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North America
United States
 
23 April 2009
CMBS Research
The Future Refinancing Crisisin Commercial Real Estate*
 
Deutsche Bank Securities Inc.All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from localexchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. DeutscheBank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a singlefactor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's researchis available to customers of DBSI in the United States at no cost. Customers can access IR athttp://gm.db.com/IndependentResearchor by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARELOCATED IN APPENDIX 1.
Special Report
Research Team
Richard Parkus
 Research Analyst(+1) 212 250-6724richard.parkus@db.com
Jing An, CFA
 Research Analyst(+1 ) 212 250-5893jing.an@db.com
   S  e  c  u  r   i   t   i  z  a   t   i  o  n
   G   l  o   b  a   l   M  a  r   k  e   t  s   R  e  s  e  a  r  c   h
   S  e  c  u  r   i   t   i  z  a   t   i  o  n
Estimates of the Magnitude of Refinancing Risk, Equity Deficiency and Losses from Maturity Defaults 
*This is a revised version of a report originally published on 22 April 2009.It contains minor corrections to the text on page 21.
 
23 April 2009 CMBS ResearchPage 2 Deutsche Bank Securities Inc.
Table of Contents
I. Introduction............................................................................................................................3
 
II. The Magnitude of the Problem.............................................................................................5
 
III. Description of the Analysis and Assumptions......................................................................9
 
IV. Estimating the Amount of Non-Refinanceable Loans........................................................11
 
 V. Equity Deficiency and Losses from Maturity Defaults........................................................15
 
 VI. Concluding Remarks..........................................................................................................21
 
 
23 April 2009 CMBS ResearchDeutsche Bank Securities Inc. Page 3
I. Introduction
The lesson that was learned (or re-learned) in the commercial real estate (CRE) crash of theearly 1990s was that problems associated with massive over-supply can plague the industryfor many years. The lesson that will be learned in the current crash (with CRE prices decliningby 40-50%, or more, from their peaks, the term crash is, once again, appropriate) is thatproblems emanating from the financing side—in particular, a massive deterioration inunderwriting standards and a concurrent rise of excessive leverage—can lead to problems ofa similar (or greater) magnitude, even without supply problems.While most attention in commercial real estate today is focused on the dramatic deteriorationin term loan performance (i.e. the performance of loans prior to maturity), we believe that apotentially even more troublesome issue is the extent to which loans originated during the2005-2007 period will encounter problems refinancing at maturity. To date, this issue haslargely been dismissed with the vague and, in our view, naive observation that lenders willsimply extend the maturity dates of loans that fail to qualify for refinancing. However, thescale of this problem is virtually unprecedented in commercial real estate, and its impact islikely to dominate the industry for the better part a decade.At its core, the issue is fairly straightforward: The dramatic weakening in underwriting qualitythat began in 2005, along with compressing cap rates and ballooning leverage, led to rapidlyrising commercial real estate prices. In 2007 the commercial real estate bubble burst, alongwith most other credit bubbles. Since that time underwriting standards have tightened backto their original levels, and perhaps further, as allowable leverage has plummeted and caprates have skyrocketed. Purely as a result of the enormous changes in the available financingterms (e.g. lower leverage, higher cap rates and credit spreads), we estimate thatcommercial real estate prices have declined 25-30% from their 2007 peak. On top of this, theimpact of the worst economic recession in decades on property cash flows will likely pushthem down additional 15-20% over and above the declines due to financing market changes.We argue in this report that, as a result, there are hundreds of billions of dollars, perhapsmore than a trillion dollars, of commercial mortgages scheduled to mature over the nextdecade that are unlikely to qualify for refinancing without substantial equity infusions from theborrowers.There are, in fact, two very different sources of refinancing problems, both of which arecurrently at play to varying degrees. The first source reflects the fact that most credit marketsare currently either shut or operating at dramatically reduced levels. The problem here is notthat maturing loans do not qualify for refinancing, but rather scarcity of credit makes itdifficult for all loans to find refinancing, even those that would normally qualify under thenew, tighter underwriting standards. Thus, in the current environment, the percentage ofmaturing loans that are able to refinance has been declining significantly since late 2008,despite the fact that the great majority of maturing loans is from the 1999 and 2000 vintages,have experienced enormous price appreciation and easily qualify for refinancing. As creditmarkets begin to heal, this source of refinancing problems will diminish.The second source of refinancing problems, as previously noted, relates to the fact that avast swath of the commercial mortgages originated during the bubble years (2005-2007) willnot qualify for refinancing under the new standards. It is this source of refinancing problemsthat we focus in this report, and this problem will not go away as credit market rebound.The focus of this report is on the refinancing problem for commercial mortgages in CMBStransactions. But CMBS is only 25% of the entire commercial real estate debt market, andthe same processes that created a vast refinancing problem here were at work, to varyingdegrees, in other segments of the commercial real estate financing market as well. Inparticular, we expect that the same type of refinancing problems will be present in both bank
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