Key Points:

• CRE refinance volume has declined from a post-pandemic peak but, despite higher interest rates, is stabilizing.
• Dollar volume of hotel refinancings is a bright spot but being driven by larger loan sizes rather than more refinance transactions, and growing hotel refinance sizes are being driven primarily by larger CMBS.
• Though CMBS credit has become increasingly accessible for large, cash-flowing hotels, smaller hotels that are struggling with cash flow or require substantial additional capital improvements have more limited options, which will likely drive hotel sales volume over the next year.

Commercial real estate (CRE) refinance transactions work a little differently than in the single-family residential (SFR) market. Unlike most SFR loans, CRE mortgages typically have a balloon payment, which means that at maturity a large portion of the loan must be repaid. 

Compared to the typical 30-year fixed-rate mortgage, where loan repayment occurs gradually over 30 years, CRE loans come due much sooner – usually between 5-10 years from origination – and require either a reserve of capital to pay off the remaining balance or a refinance to replace the existing loan with a new one. Consequently, CRE refinancings are often a necessity, rather than a convenience. When a property owner isn’t planning to sell and their mortgage matures, refinancing becomes the only option if they lack sufficient capital to cover the balloon payment. 

In this X-Factor, we’ll look at recent trends that suggest the CRE refinance market is stabilizing, and even growing in the case of hotels. 

“Though CRE refinance volume has declined over the last two and a half years, it appears to be stabilizing and, in the unique case of hotels, growing.”

CRE Refinancing Volume is Mostly Down, But Has Stabilized

Higher interest rates have depressed CRE refinance volume compared to the peak monthly volume reached in December 2021 when rates were at historic lows. However, despite today’s higher rates and a 10-year Treasury yield that’s 2 percentage points higher than its 2016 average, $20 billion worth of CRE refinancings still closed in August of this year, which is a little above the average monthly refinancing volume in 2016 of $19 billion. 

Since monthly refinance activity can be volatile, refinance volume is shown on the following chart on a trailing 12-month basis (TTM). The slowing rate of decline is clearly visible, suggesting that CRE refinance volume is stabilizing and is likely to increase as additional interest rate cuts materialize. 

Refinance Volume has Declined from the Post-Pandemic Peak for Most Asset Classes, Except Hotels

Compared to its post-pandemic peak levels, CRE refinance volume has fallen for almost all asset classes. The chart below shows the decline in refinance volume relative to peak on a TTM basis, which occurred in May 2022. The decline in refinance volume has been most severe for office properties, followed by apartments. However, hotels stand out as the only asset class in which refinance volume has increased over the same period. In fact, the second quarter of 2024 was the most active second quarter for hotel refinancings over the last 25 years, and the third most active of any quarter. While that pace has slowed somewhat in the third quarter, it still raises the question: what’s driving this counter-trend surge in larger hotel refinance volumes compared to other asset classes?

Refinance Loan Sizes are Growing, Especially for Hotels

One area to investigate is the average size of refinance loans, which is growing for all asset classes. However, the size of hotel refinancings has increased the most in both absolute terms and relative to other asset classes. At the same time, despite the growth in dollar volume of hotel refinancings compared to the post-pandemic peak, the number of hotel refinance transactions has declined. Instead, the higher dollar value of refinance volume is being driven by larger average hotel loan sizes. 

In the past, the size of hotel and office refinancings have roughly tracked one another, and when they have deviated it was due to hotel refinance sizes sinking below those of office refinancings. That changed mid last year. Since May 2023, the average size of hotel refinancings has pulled far ahead of office refinancings, with the average size of a hotel refinance increasing by 54 percent, from approximately $10 million to $15 in August 2024. 

Taken together, these developments suggest that, while fewer hotels are being refinanced overall, the higher dollar value of refinances is being driven by larger loan sizes. The divergence in hotel loan sizes compared to office, as well as declining refinance volume for office properties, suggests that lenders are becoming more confident that they can assess the value of large hotels as compared to large office buildings, which are facing longer-term challenges. However, the larger average dollar size of hotel loans is also in part due to hotel property values increasing, while office prices have fallen. We may not need as much office space as we did pre-pandemic, which creates uncertainty around what these properties are worth. Remote work continues to dampen office demand, but people are still traveling and spending on experiences, and when they do, they need a place to stay. This shift towards experiential spending, which has also occurred in the retail sector is particularly benefitting luxury hotel destinations.

For Large, Cash-Flowing Hotels, the CMBS Refinance Market is Open for Business

Bigger commercial mortgage-backed securities (CMBS) loans have been the primary driver of larger hotel refinancings. While the average size of all hotel refinancings has grown since last May, non-CMBS hotel refinance sizes have only grown by about 22 percent, from $12.7 million to $15.5 million. By comparison, CMBS hotel refinance sizes have grown by 155 percent, from $17.8 million to $45.3 million. This trend is shown in the top part of the following chart. The bottom portion of the chart shows the total count of hotel refinancings broken out by CMBS and non-CMBS loans. Although the total number of hotel refinancings has decreased, CMBS refinancings have been growing. However, non-CMBS refinancings still outnumber CMBS ones, contrasting with the pre-pandemic period when CMBS accounted for, at times, half or more of all hotel refinancings. 

The takeaway? If you have a large hotel that’s generating enough income, then the CMBS refinancing market is open for business.

So, What’s the X-Factor?

Though CRE refinance volume has declined over the last two and a half years, it appears to be stabilizing and, in the unique case of hotels, growing. The dollar value of hotel refinancings does not appear to be driven by a greater number of hotel refinancings, but by greater average loan sizes, especially in the CMBS market. This suggests that larger, profitable hotels are currently able to access the CMBS refinance market with relative ease.

On the other hand, smaller hotels with cash flow issues or substantial capital improvement requirements are still struggling to access attractively priced credit. Owners of these types of hotels are more likely to sell, take the loss, and move on. This latter trend is likely to drive higher hotel sales volume in the years to come.