What Will the CRE Lending Environment Look Like in 2019?
Top 8 Take-Aways from the 2019 CREF Conference
San Diego, CA February 2019
It was great to visit with many of our lenders at the 2019
CREF Conference in San Diego last week! After
gathering our Loan Originators and discussing the tone and topics at the
conference, here are some of our most important take-aways:
- Backwards
Baseball: Last year the general feeling was that we were in the “9th
Inning” of the CRE cycle. This year, lenders
felt that we are in the 7th or 8th inning (strange game
we are playing!). My take on this is
that since Chairman Powell announced that the Fed will slow its pace of rate hikes
in 2019, the CRE market will continue to behave much like it did in 2018, yet
lenders still recognize that we are probably closer to the end of the cycle
than the beginning. - Cautious
Capital: At the 2017
conference, our life company lenders seemed to have unlimited capital to
deploy. In 2018, they said they would be happy lending the same amount as the
year before (the same allocations). This
year, most life companies had a, “proceed with caution” attitude and few life
companies were looking to deploy more
capital than they did in 2018 (although most are happy to keep production
consistent). CMBS and Agency
originators, as well as debt funds, will continue to have unlimited appetites. Although not many banks were present at the
conference, our sense is that bank underwriting will tighten in 2019,
reflecting their increasingly cautious outlook. - Treasuries
Rose: Now Leveling Off. A good
indication of where lenders think interest rates are headed is the cost of
forward commitments. For as little as 2
bps/mo. added to the interest rate (beyond the first 90 days which are free),
our life insurance companies will offer forward commitments to the end of this
year. Said differently, for an
additional 12 basis points in rate, our life companies will lock in a rate
today which will fund in this December (assumes 3/1/19 application to 12/1/19
funding). That’s pretty amazing when you
think about it! Several of our
borrowers with loans maturing in 2019 have expressed interest in taking
advantage of this amazing opportunity. - Spread
Headwinds: All CRE debt spreads will face competition from the
corporate bond market. Whether you
subscribe to the theory that corporate bonds yields are increasing due to the
mention of the “R” word, or the theory that increased rates are the result of
corporate America stressing their balance sheets with more debt to address
robust growth, commercial real estate mortgage spreads will face increased competition
from the corporate bond market. Don’t
count on CRE debt spreads to decline anytime soon. As of this writing, most 10-year
spreads to treasuries range from 130bp – 170bp depending on a number of
factors. - Market Prices
Unch: The gap between cap
rates and long-term borrowing costs is at its narrowest point since 2007. For many multifamily investments this gap is
non-existent or negative. Lender
underwriting is strained as there just isn’t enough cash flow to service higher
levels of debt. As a result, most acquisitions
will either be: all cash, involve substantial down payments, be in secondary
markets where cap rates are higher, or be storied/value-add deals where the
spread between cap rates and the cost of long-term money is largely irrelevant.
Buyers will be forced to invest more
cash in deals until sellers adjust to the new pricing reality (or until long
term rates come down). Life insurance companies
will continue to finance acquisitions because the rest of the market has come
back to their level of conservative underwriting and they have superior pricing
over these competitors. - Pivot to
Debt Funds: We heard at the
conference that there are now ~150 “debt funds” in the marketplace (a
substantial increase from a year ago) and a declining number of CMBS lenders. I define Debt funds as those unregulated,
private-equity lenders which include mortgage REITs, sovereign wealth funds,
and general pools of debt aggregated from private sources. Debt funds provide non-recourse,
interest-only bridge, heavy renovation, and construction lending for medium to
large sized projects, and they generally absorb more risk than traditional
lenders (and they are paid for it).
Spreads in this space have come down considerably over the past year,
but costs remain extremely high relative to traditional financing sources
(origination fees, exit fees, LIBOR caps, lender’s legal costs, outsourced
reviews, etc.). Debt funds will continue
to be a popular source of financing for ground up construction, value-add, and
storied deals as long as demand for this sort of capital remains high. Based on the number of originators, my guess
is that spreads will continue to drop, costs will come down, and the amount of
risk they take will go up – all good news for borrowers in this space. - Property
Types: It seems as though
industrial remains the most desired property type in spite of worldwide trade
tensions. Industrial demand is being fed
by our increased desire to shop online rather than to going to the store –
which shifts demand from retail storefronts to warehouse distribution
properties. However, lenders still love well-located, grocery-anchored
neighborhood shopping centers. Several
lenders shared concerns about certain multifamily markets which have seen
significant new supply. Office and
self-storage properties are favored but hospitality properties are not. - Opportunity
Zones: Lenders are taking a ‘wait
and see’ approach to opportunity zone funds and their capital needs. One concern is that investors will overpay
for real estate in secondary locations simply to avoid paying taxes. Another concern is that these investment
vehicles will end up looking a lot like syndications, which lenders generally
dislike. The opportunity zone landscape
is still very cloudy and there is still a lot to be learned and studied in this
area. My guess is that traditional
lenders will be very hesitant to fund land acquisitions in opportunity zone
areas, and that traditional construction lenders will be hesitant to fund
construction projects in these areas.
However, one thing is for certain: some capital source will see this
demand and try to fill the gap.
Taken as a whole, it looks like abundant equity capital is
chasing very few deals (which make sense due to narrow margins) so there is a push
to make deals make sense through
value-add deals. Lenders are responding to this demand by shifting toward new
and innovative debt products.
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