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:

  1. Backwards
    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.
  2. Cautious
      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.
  3. 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.
  4. Spread
    : 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
  5. Market Prices
      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.
  6. 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.
  7. Property
      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.   
  8. Opportunity
    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.