To say it’s been a turbulent ride the past several months in the lending and commercial real estate world would be quite the understatement! As the Fed made their moves to combat inflation, a series of unintended consequences occurred – not the least of which was the impact of increasing rates on commercial lending. While increases in overall rates have not been as extreme as moves in the Fed Funds or Discount rate, they have had a major impact on the leverage level for real estate loans and consequently transaction volumes. Related to all of that, I’ve noticed 3 phenomena which I discuss below.
First and foremost, while most lenders have not increased debt coverage requirements as a hedge against risk, rising rates – simply – put decrease the amount of leverage available. Where we saw 75-80% lending on multifamily and 75% on most commercial loans, we now see 60-70% across the board regardless of region. That decrease has essentially cratered overall commercial lending activity by over 70%. Unfortunately, until the sale market catches up to some degree with increased cap rates, I don’t see reason for those leverage levels to increase absent a decrease in interest rates.
Second, as many have noticed, we are seeing a consolidation of banks with mergers and acquisitions, along with a few failures. It needs to be noted that the few failures have been for very specific reasons which are not present generally in the banking system. That said, it appears banks have begun trying to stockpile cash reserves – with some doing so as a means to acquire less healthy smaller banks. For us here in the Pacific Northwest, in the past 6-8 months, we have seen the takeover of at least two major regional lenders by larger banks as well as two or more acquisitions of larger credit unions buying smaller credit unions. The impact on commercial lending will sadly not be positive as in each and every case, the larger institution had much less appetite for commercial real estate lending and as importantly any appetite for smaller CRE loans (less than $5m). That is something we in the commercial mortgage brokerage community will need to navigate going into the future.
Third, we haven’t seen sellers adopting the new reality in the lending space with increased rates that should naturally put at least some upward pressure on cap rates. Sponsors who purchased properties in the past 2-4 years cannot afford to sell at higher cap rates since that would eliminate any profits as increased NOI would be offset by the higher caps. Moreover, those borrowers will generally have more favorable existing loan terms, therefore why exchange for no value gain, higher rates and lower leverage. On the positive side, we have seen sellers with hold times of 5-10 years still in the market to sell acknowledging that you seldom sell at the top or buy at the bottom. Those sellers – and admittedly there are not many yet – still have increased value on their side. However, on the whole, sale volumes are obviously way down with few sellers in a position of wanting or needing to sell, hence no real move in cap rates… yet.
Despite all of this, loans are still closing and there are some sales. The markets need time to adjust! Most importantly for everyone to understand: this is not 2009. There is a lot of lending capacity and once the Fed moves stop (likely in May) that capacity will come back into play. And while lenders currently may not be moving out of their standard underwriting boxes, they are still lending within those boxes. The fact that the overlap between lenders now in their guidelines has shrunk dramatically makes using folks with a lot of contacts helpful – and that’s where commercial mortgage brokers like Commercial Lending Group can help! 🙂
