Maturing Loan In A High-Interest Environment

Thousands of physicians who financed medical office building purchases in the low-rate environment of 2015-2021 now face a challenging situation: loans are maturing, and refinancing rates have doubled or tripled from their original financing. For many, the increase in debt service threatens practice cash flow and forces difficult strategic decisions.

If your medical property loan is maturing in the next 12-24 months, understanding your options and planning proactively can help you navigate this challenging environment while protecting your financial interests.

Understanding the Challenge

The Interest Rate Shock

The Federal Reserve's aggressive rate hiking cycle created one of the sharpest increases in borrowing costs in modern history:

• 2019-2021 Rates: Medical office building loans typically ranged from 3.5-4.5%
• 2023-2024 Rates: Comparable financing jumped to 7.0-8.5%
• Rate Increase: 300-400 basis points (doubling of interest cost)

This dramatic shift has significant cash flow implications:

Example Scenario:

• Original loan (2019): $5 million at 4.0%, 25-year amortization = $26,396/month
• Refinancing (2024): $4.5 million at 7.5%, 25-year amortization = $33,219/month
• Monthly payment increase: $6,823 (+26%)
• Annual debt service increase: $81,876

For many practices, an additional $80,000+ in annual debt service significantly impacts profitability and physician compensation.

The Maturity Wall

The volume of medical property loans maturing in 2024-2026 is substantial:

• Many loans originated during 2014-2016 with 10-year terms are maturing now
• Loans from 2019-2021 with 5-year terms are approaching maturity
• Balloon payments requiring refinancing or payoff are coming due

This creates a "maturity wall" where large numbers of physician-owners face refinancing simultaneously in an unfavorable rate environment.

Strategic Options for Maturing Loans

Physicians facing loan maturities have several strategic paths forward, each with distinct advantages and trade-offs:

Option 1: Conventional Refinancing

The Approach: Refinance the existing loan with a new conventional commercial mortgage at current market rates.

When It Makes Sense:

• You plan to hold the property long-term (10+ years)
• Property generates sufficient NOI to support higher debt service while maintaining acceptable debt service coverage ratios (DSCR)
• Practice cash flow can absorb the increased payment
• You believe rates will remain elevated or increase further (making waiting counterproductive)

Key Considerations:

• Loan-to-Value Requirements: Lenders typically require 65-75% LTV, potentially requiring principal paydown if property values have declined
• DSCR Requirements: Most lenders require 1.25x DSCR minimum, which may necessitate reduced leverage
• Rate Lock Options: Consider locking rates if you see further increases likely
• Prepayment Penalties: Evaluate prepayment terms in case rates decline and you want to refinance again in 3-5 years

Financing Sources:

• Regional and community banks (often best rates for medical office)
• Credit unions (competitive rates, relationship-focused)
• CMBS loans (larger properties $5M+, fully amortizing available)
• Life insurance companies (highest-quality properties, long-term fixed rates)

Option 2: Loan Extension Negotiation

The Approach: Negotiate an extension of your existing loan rather than full refinancing, betting that rates will decline in the near future.

When It Makes Sense:

• Current loan has favorable terms you want to preserve
• You believe rates will decline significantly in 12-24 months
• Refinancing costs (appraisal, legal, title, etc.) are substantial relative to loan size
• Your existing lender values the relationship and is willing to negotiate

Extension Structures:

• Short-Term Extension: 1-3 years at higher rate (still below market refinancing) to wait out rate environment
• Rate Adjustment: Extend at current margin over benchmark rate (e.g., SOFR + 250 bps)
• Hybrid Structure: Short extension with option to convert to longer-term at specified rate if rates remain elevated

Negotiation Tips:

• Emphasize your payment history and relationship with lender
• Provide updated property financials showing strong performance
• Be prepared to provide updated appraisal or property condition report
• Understand that lenders are often willing to extend rather than force refinancing at rates that might cause default

Option 3: Sale-Leaseback Transaction

The Approach: Sell the property to an institutional investor and lease it back, using sale proceeds to pay off the loan while continuing to occupy the space.

When It Makes Sense:

• Current loan balance is significantly less than property value
• You need liquidity for practice investment, retirement planning, or diversification
• Property management has become burdensome
• You want to eliminate refinancing risk and property ownership responsibilities
• Lease rates are comparable to or lower than refinanced debt service + property expenses

Financial Example:

Property worth $8 million with $4.5 million loan maturing:

• Sale proceeds: $8 million
• Loan payoff: $4.5 million
• Net proceeds to physician: $3.5 million (before taxes and closing costs)
• Leaseback rent: $520,000/year (6.5% of value = typical sale-leaseback rate)
• Previous debt service + expenses: $475,000/year
• Additional annual cost: $45,000, but gained $3.5M liquidity

Key Advantages:

• Immediate liquidity without capital gains tax (if structured as 1031 exchange or UPREIT)
• Eliminate refinancing risk and property management burden
• Convert illiquid real estate into liquid capital for diversification
• Rent expense is fully deductible (whereas only loan interest was previously deductible)

Option 4: Outright Property Sale

The Approach: Sell the property entirely and relocate practice or lease space elsewhere.

When It Makes Sense:

• Property location no longer optimal for practice
• Building requires significant capital investment (roof, HVAC, parking lot, etc.)
• Approaching retirement and don't want long-term real estate obligations
• Property has appreciated significantly and you want to realize gains
• Practice is being sold and buyer prefers leased space

Financial Considerations:

• Capital Gains Tax: Sale triggers capital gains tax (23.8% federal + state) unless tax-deferred structure is used
• Relocation Costs: Moving expenses, build-out of new space, patient communication
• Future Rent: Compare rent expense at new location vs. refinanced debt service at current property

Option 5: Partner Capital Infusion

The Approach: Bring in capital partner to pay down debt, reducing refinancing amount and debt service burden.

Structure Options:

• Equity Partner: Sell 25-49% ownership to investor who contributes capital for debt paydown
• Preferred Equity: Investor contributes capital in exchange for preferred return (e.g., 8% annually) before physicians receive distributions
• Mezzanine Debt: Subordinated loan from private lender at 10-12% (higher cost but less dilutive than equity)

When It Makes Sense:

• You want to maintain ownership but lack capital for significant paydown
• Property has strong appreciation potential you want to participate in
• Bringing in experienced partner can improve property management and value

Option 6: Practice-Level Solutions

The Approach: Increase practice revenue allocated to property expenses to absorb higher debt service.

Strategies:

• Rent Increase to Practice: If you own both property and practice separately, increase rent paid by practice to property entity (market-rate, tax-deductible to practice)
• Sublease Excess Space: If building is partially vacant or you've downsized, lease unused space to other healthcare providers
• Adjusted Partner Distributions: Reduce partner distributions temporarily to maintain cash reserves for debt service

Decision Framework: Choosing Your Path

Selecting the right strategy depends on multiple factors:

Financial Position Assessment

Strong Financial Position:

• Loan balance is 50-65% of property value
• Practice generates strong cash flow
• Low personal debt and strong liquidity
• Best Options: Conventional refinancing, loan extension

Moderate Financial Position:

• Loan balance is 65-75% of property value
• Practice cash flow is adequate but not robust
• Limited liquidity for large principal paydown
• Best Options: Loan extension, sale-leaseback, partner capital

Stretched Financial Position:

• Loan balance exceeds 75% of property value
• Practice cash flow is constrained
• No liquidity for principal paydown
• Best Options: Sale-leaseback, outright sale, aggressive loan extension negotiation

Timeline Considerations

Immediate Maturity (0-6 months):

• Limited time for alternatives
• Focus on refinancing or extension
• Begin sale-leaseback exploration only if process can close within 90-120 days

Near-Term Maturity (6-12 months):

• Sufficient time to explore multiple options
• Can pursue sale-leaseback or outright sale
• Negotiate refinancing terms while exploring alternatives

Medium-Term Maturity (12-24 months):

• Optimal time to strategize
• Can wait for potential rate declines before committing to approach
• Time to improve property financials (renew leases, increase occupancy) to support better financing

Personal and Practice Goals

Long-Term Practice Continuation: If you plan to practice 10+ years, refinancing or extension makes sense to maintain ownership and benefit from future appreciation.

Approaching Retirement (5-10 years): Sale-leaseback provides liquidity now while allowing continued practice operations. Avoid long-term refinancing that creates future refinancing obligation near retirement.

Near-Term Exit (0-5 years): Sale-leaseback or outright sale often make more sense than refinancing. Avoid taking on long-term debt you'll need to satisfy during practice sale.

Common Mistakes to Avoid

1. Waiting Until the Last Minute

Many physicians ignore maturing loans until 30-60 days before maturity. This eliminates options and forces acceptance of whatever terms are available. Begin planning 12-18 months before maturity.

2. Accepting First Refinancing Quote

Lenders vary significantly on rates, terms, and fees. Always get 3-5 competitive quotes. Differences of 25-50 basis points are common and materially impact long-term costs.

3. Ignoring Tax Implications

Sale strategies trigger capital gains tax unless structured properly. Failing to explore 1031 exchanges, UPREIT contributions, or installment sales can cost hundreds of thousands in unnecessary taxes.

4. Overlooking Extension Options

Many physicians assume they must refinance without exploring extension possibilities. Existing lenders are often willing to extend rather than force borrowers into challenging refinancing.

5. Emotional Decision-Making

Attachment to property ownership can cloud judgment. Make decisions based on financial analysis, not emotion. Sometimes the best decision is letting go of ownership to preserve practice profitability.

The Rate Outlook: Should You Wait?

One critical question: should you refinance now or wait for rates to decline?

Arguments for Acting Now:

• Rate cuts may be limited (50-100 bps) and won't return to 2019-2021 levels
• Waiting creates uncertainty and maturity deadline pressure
• Property values may decline if economy weakens, making refinancing harder later
• Lock in certainty now and refinance again in 3-5 years if rates drop significantly

Arguments for Waiting (via Extension):

• Fed has signaled rate cuts are coming
• Each 50 bps of cuts meaningfully improves refinancing terms
• Extensions of 12-24 months may allow refinancing at 6.0-6.5% vs. 7.5-8.0% today
• Avoid long-term lock-in at peak rates

Balanced Approach: Negotiate extension of 12-24 months if possible, giving flexibility to refinance when rates improve while avoiding long-term commitment at current peak rates.

Action Steps

If your medical property loan is maturing in the next 12-24 months:

Immediate Actions (Maturity Within 12 Months):

1. Request payoff statement and review loan maturity terms
2. Obtain updated property valuation (appraisal or broker opinion of value)
3. Analyze current property financials (NOI, occupancy, lease expirations)
4. Calculate debt service coverage ratio for refinancing scenarios
5. Contact 3-5 lenders for refinancing quotes
6. Approach current lender about extension possibilities
7. Consult with CPA about tax implications of various strategies

Strategic Planning (Maturity 12-24 Months Out):

1. All immediate actions above
2. Engage healthcare real estate advisor to evaluate sale-leaseback potential
3. Model financial impact of each strategic option
4. Consider whether property improvements might support better financing
5. Evaluate personal retirement timeline and how it affects strategy
6. Discuss with partners/co-owners to ensure alignment on approach

Conclusion: Proactive Planning Makes All the Difference

Facing loan maturity in a high-interest environment is undoubtedly challenging. For many physicians, doubling of debt service significantly impacts practice profitability and personal finances.

However, physicians who plan proactively have multiple strategic options beyond simple refinancing at market rates. Loan extensions, sale-leasebacks, partner capital, and strategic sales all provide viable alternatives that can preserve financial stability while navigating the rate environment.

The key is beginning the planning process early—ideally 12-18 months before maturity—and working with specialized advisors who understand both healthcare real estate markets and the unique financial dynamics of physician practice ownership.

With proper planning and expert guidance, physicians can navigate loan maturities successfully, making strategic decisions that protect practice operations while positioning themselves for long-term financial success.