Current State of CRE Debt Capital Markets

By Mike Gurtovoy

As things have finally shaken out in the lending market amid Covid-19, we are starting to see some clarity in the lending market and a clear pathway toward recovery. Below are some of our observations from each lending source:

Banks & Credit Unions

In general, many banks are still lending but extremely selectively (most are so selective that they have only done a handful of deals over the past 2 months, and many haven’t done a single deal). Over the last couple of months, government programs such as PPP helped keep banks busy and many of the loans are currently in the process of being forgiven by the government. Many businesses will not end up making it and there is going to be a big hit to the banks’ balance sheets in the near future. Due to this large potential near term risk, banks are keen on keeping their balance sheets liquid which means drastically limiting the amount of risk they are looking to take on. Since there are less banks doing CRE deals, banks which are still in the market can cherry pick the deals to lend on (and borrowers to lend to), which in this time period, are straight down the runway deals such as stabilized multifamily and industrial properties (or conservative “relationship” deals). Banks are also being opportunistic in putting a premium on deposits since it allows them to solidify both existing relationships and form stronger new ones.

Life Insurance Companies

Life Insurance Companies have less exposure to local business than banks and have a very steady stream of premiums which they need to invest. However, given their more conservative nature, they are even more conservative than they have been in the past and are looking to lend closer to 50% LTV. Additionally, Life Insurance Companies do not necessarily need to invest in commercial real estate paper, and often cross-shop returns from CRE loans with corporate bonds. Since bonds spreads have blown out dramatically amidst Covid, life insurance companies are also demanding the same which is translating into higher spreads paid by borrowers. However, with each passing day, spreads have been compressing.

CMBS

CMBS markets were virtually non-existent until the Fed expanded TALF (“Term Asset-Backed Securities Loan Facility”) to include AAA conduit CMBS. Like Life Insurance Companies, pricing is dependent on bond spreads which have been coming down recently but are still considerably higher than they were Pre-Covid. CMBS lenders have buttoned down their underwriting and are excluding retail and hospitality from consideration.

Debt Funds

There is a lot of variance regarding the state of debt funds. In general, lenders with the cheapest access to capital have the best rates and that became very apparent in the debt fund space leading up to Covid. Pre-Covid, lenders who had access to CLO issuances, became the cheapest source of capital with rates which allowed them to compete directly with banks. As of now, the CLO market has not been a direct beneficiary of TALF and lenders which relied on the CLO market are mostly out of commission. The next best thing for debt fund lenders were favorable warehouse lines and access to the Repo market. Warehouse lenders have pulled back massively and the Repo market has shown flashes of trouble due to the Mark-to-Market provisions (Tom Barrack does a nice job explaining this here: https://medium.com/@tombarrackjr/unpacking-the-coronavirus-aid-relief-and-economic-security-act-cares-act-a605426dffa8).  As such, those lenders are either not lending or are lending on more conservative deals at higher pricing. Pre-Covid, a few debt funds had a sizable balance sheet which they did not leverage. Those funds needed a higher rate of return which translated to traditionally much higher pricing. Those debt funds are seeing the least amount of impact but are lending on more conservative deals due to decreased competition.

Agency

Agency lenders in general have seen the least amount of impact and are still lending very strongly. Fannie & Freddie rates have dropped dramatically and are now at or near record lows. The FHA/HUD program got a slight revamp which cut the closing timeline by about 50%. There is a great amount of emphasis around collections rates and the impact that Covid has had on them. Fannie & Freddie also now require a 12-month Debt Service Reserve (6-months if very conservative) and cashout proceeds are now more limited. Overall, leverage is more conservative, but the rates are incredibly compelling.

Advice to Borrowers and the Road Ahead

Right now is a good time to look at perm lending options with rates as low as they’ve ever been across agency platforms, and with life company rates dropping weekly to near Pre-Covid lows. Bridge lending is existent but is pricing substantially higher than it was Pre-Covid. If costs and timing are currently advantageous, it may still make sense to pull the trigger, however if waiting for spreads to drop is an option, it may be the right time to prime deals for quick execution. Construction lending is currently incredibly difficult, though it is still possible for strong deals and sponsors. The best way forward for construction deals is to be patient and prep deals for a smooth execution. Liquidity is king and may help win a bank deal if moving deposits around to demonstrate a relationship is an option. It is wise to have prepared answers to specific Covid-19 related questions in regard to both the building being financed and the overall portfolio. Smart money will tee deals up now to take advantage of brief windows where financing options open up during this volatile time.  Overall outlooks within the market are trending positive and we expect most lenders to become more competitive and spreads to continue to trend downward as we recover out of this pandemic and lenders follow the herd back to normalcy.

We’d appreciated any comments or questions from both Lenders and Borrowers.

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