Debt Markets Revisited
CBRE'‘s debt team recently provide a great summary of the capital markets following their visit to the Western States CREF Conference last week. Their reflections were well-timed. Soon after, the Fed announced it’s first rate cut of 50 bps. The move has the potential to shift markets in the coming months. CBRE’s commentary highlights what some of these moves might look like. A few key notes below:
The decline in interest rates has positively impacted lending activity, particularly for multi-family and industrial properties, which remain highly favored. Retail properties are also seeing renewed interest, expanding beyond traditional grocery-anchored centers with an increase in demand for strip, neighborhood, and regional power centers. Debt for office continues to be challenged with those lenders willing to lend on the asset class preferring Class A, stabilized properties with strong credit tenants, best-in-class sponsors, and a diversified rent roll.
A significant portion of CRE debt, approximately $1.7 trillion, is set to mature between 2024 and 2026. This “maturity wall” presents a substantial refinancing opportunity, as many loans will need to be repriced at higher interest rates. The ability of borrowers to navigate this period will be crucial in determining the market’s stability.
The large number of refinances combined with increased interest rates has raised some concerns. Late-cycle loans will almost universally require a cash-in refinance. Many borrowers have been shielded from the full impact of interest rate increases due to interest rate caps, but many of those are maturing and will need to be reset at higher rates. The decline in the US Treasuries and the anticipated moves by the Fed should help mitigate these concerns.
CMBS lenders are playing a more active role often involving higher leverage and interest only loans. As the economy continues to recover, there is a growing demand for CMBS financing across various property types, including office, which has been an asset class difficult to finance. Additionally, the decrease in spreads by 75-100 basis points on 5 and 10-year term money has made borrowing more attractive.
Banks continue to be under pressure to maintain ample cash reserves and are requesting significant deposits from prospective borrowers to obtain modest leverage. Although active in the owner-occupied space, there has been a shift driven by strong demand back into the investment space. This renewed focus will help fill the void of the banks seen over the last 18 months. Although not at full capacity, expect increase lending activity from the local, regional, and national banks going forward.
Private debt funds continue to step up to fill the void left by banks, particularly within the bridge and construction sectors. While these lenders are providing a path back to leverage in the 65% - 70% LTC range, the pricing is significantly higher, and many LP equity partners are hesitant to commit with yields on cost typically in the low to mid 6% range and all-in construction capital costs at 8.50% to 10.50%. However, with SOFR expected to decline in the foreseeable future, floor rates will be the primary focus for borrowers.
Institutional real estate equity has largely remained on the sidelines, cautious due to market volatility and economic uncertainties and pivoted to a risk adjusted return redeploying into preferred equity and mezzanine lending vehicles in the 10% to 15% range, depending on type and structure of the senior loan being applied. However, there are signs of renewed activity as these investors begin to re-enter the market. Factors such as stabilizing economic conditions, adjusted valuations, and the potential for long-term growth are driving this resurgence. This shift indicates a growing confidence in the market’s recovery and a strategic move to capitalize on emerging trends.