Rollover Probability

Definition of Rollover Probability

In the context of commercial real estate finance, Rollover Probability (also known as maturity risk or refinancing risk) refers to the statistical likelihood that a borrower will be unable to successfully refinance an existing commercial mortgage when it reaches its maturity date. Unlike residential mortgages, which are often fully amortizing over 30 years, most commercial mortgages are structured as "balloon" loans with shorter terms—typically five to ten years—requiring the borrower to either pay the remaining principal in full or secure a new loan to "roll over" the debt.

Detailed Description and Key Drivers

Rollover probability is a critical metric used by lenders, investors, and credit rating agencies to assess the stability of a commercial real estate portfolio. When the probability of a successful rollover is low, the risk of technical default increases significantly, even if the property is currently generating positive cash flow. Several interconnected factors influence this probability:

• Interest Rate Environment: This is the most significant driver of rollover probability. If market interest rates have risen significantly since the original loan was originated, the cost of a new mortgage may exceed the property's ability to service the debt, making refinancing difficult or impossible without additional equity.
• Debt Service Coverage Ratio (DSCR): Lenders use the DSCR to determine if a property’s Net Operating Income (NOI) can cover the debt payments. If a property's income has declined or if new, higher interest rates lower the DSCR below a certain threshold (typically 1.20x to 1.25x), the rollover probability decreases.
• Loan-to-Value (LTV) Ratios: If the market value of the property has depreciated, the borrower may find that their existing loan balance exceeds the maximum LTV allowed by new lenders. This creates an equity gap, where the borrower must contribute significant cash to "pay down" the loan to a level that can be refinanced.
• Capital Markets Liquidity: Rollover probability is also tied to the overall availability of credit. During periods of economic instability or banking crises, lenders may tighten their standards or exit certain asset classes (such as office space or retail), making it harder for even high-quality borrowers to find a replacement loan.
• Tenant Stability and Lease Expirations: If a commercial property faces major lease expirations at the same time the mortgage matures, lenders view the rollover as high-risk. A lack of weighted average lease term (WALT) can lead to a rejection of the refinance application until new tenants are secured.

Impact on the Market

When rollover probability becomes a systemic concern across an entire sector, it can lead to forced sales. If a borrower cannot refinance and does not have the liquid capital to pay off the balloon balance, they may be forced to sell the asset in a "fire sale" environment, which further depresses property values in the surrounding area. Consequently, analysts monitor maturity "cliffs"—periods where a high volume of commercial debt is due simultaneously—to gauge the overall health of the financial system.