Borrowers are reveling in a market where capital is both cheap and plentiful, and even an expected rise in interest rates is not likely to take the wind out of the sails of the current robust lending climate.
“We’re enjoying the benefits of a great market,” says Ernie Katai, executive vice president and head of production at Berkadia, a commercial real estate company. Although 2014 was a record year for the firm in financing, year-over-year volume surged another 70 percent in 2015. Part of that jump can be attributed to a single $5.1 billion portfolio transaction. But excluding that deal the firm’s numbers would still be up 40 percent for the year, notes Katai.
Based on overall market liquidity, that momentum is expected to carry over into 2016. Lenders are keeping an eye on international headlines, notably the recent terrorist attacks and continued threats in Europe. However, lenders and financial intermediaries remain optimistic about the coming year. “Short of something outside of our control happening, the market for 2016 looks poised for another strong year,” Katai says.
Activity has been steadily on the rise across the board. The continued low interest rate environment and growth in property incomes and values are among those factors fueling lending activity. Borrowers clearly have a bigger appetite for capital with the looming wave of loan maturities, as well as increasing volumes in both investment sales and new construction projects.
In the third quarter of 2015 commercial and multifamily mortgage loan originations were 12 percent higher than during the same period last year, according to the Mortgage Bankers Association's (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. In addition, the MBA is predicting a 6 percent increase in commercial/multifamily mortgage originations in 2016 with new originations of $485 billion. That activity would raise the total commercial/multifamily mortgage debt outstanding by a further 1.8 percent by year-end 2016 to $2.8 trillion, the organization forecasts.
“I would anticipate that 2016 is going to be pretty much steady as she goes. I don’t see any reason for it not to be at this point,” says Larry Stephenson, a senior executive vice president and regional managing director at NorthMarq Capital, a servicer and provider of commercial real estate debt and equity, in Minneapolis. The firm is projecting a modest rise in financing volume from $12 billion in 2014 to an anticipated $13 billion this year with a similar upward trajectory for the coming year.
Abundant capital sources
Business is up across all lending sources and all property types. “That speaks to the volume of the market and the liquidity and strength of the market,” says Katai.
Banks are stepping up their lending and providing tough competition on 10-year loans with no recourse, notes Stephenson. “I don’t know how they are doing it, because at some point, if short-term rates start to tick up, they are going to have long-term liabilities on their books that are not going to match up with their income,” he adds.
At the same time, banks are starting to tighten construction lending and focusing on their better borrowers. That is opening the door to some hedge funds, which are beginning to show interest in construction loans. Hedge funds are willing to go up to higher leverage—75 percent—in order to garner a slightly higher yield.
Life insurance companies
Life insurance companies are generally winning low-leverage loans, those with loan-to-value ratios (LTVs) below 60 percent, and they also are attracting borrowers looking for long-term money. Life companies will offer 25-year term and 25-year amortization or even 30-30 deals, notes Katai. Life companies are also differentiating themselves with their flexibility on pre-pay.
More capital has been flowing to private equity funds focused on mezzanine and bridge loans. Private equity real estate debt funds are coming off a huge year of fundraising success in 2014. According to London-based research firm Preqin, nine U.S.-focused closed-end private real estate debt funds with a mezzanine financing component closed last year with an aggregate capital raise of $7.6 billion—nearly four times the $1.6 billion raised in 2013.
In addition, private equity may see a boost from sovereign wealth funds in the future. These groups have a lot of dollars to put out, and they are reportedly looking for more creative ways to place that capital in U.S. real estate.
The CMBS market has been a bit volatile in the second half of the year with spreads widening. Yet the current forecast for 2015 U.S. issuance is that it will top last year’s $94 billion, with issuance that will likely end north of $100 billion. Wider spreads on CMBS issuance are leading to higher rates for borrowers of 50 to 75 basis points. Most buyers are willing to pay the higher rates in exchange for securing more dollars, and conduits are still aggressively lending on stabilized property types with leverage of around 75 percent. The broader financing market is also continuing to watch the wall of CMBS loan maturities that will hit the market in 2016 and 2017.
It will likely be business as usual for Fannie Mae and Freddie Mac in 2016. Both agencies are expected to have caps for market rate deals that are set at similar levels to 2015. At around $30 billion each, that represents a sizable amount of potential lending volume for the multifamily sector.
Trends to watch in 2016
Despite the positive sentiment, there will be some notable trends to watch in 2016 that could influence the lending climate for borrowers. Chief among those issues will be the start of rising interest rates, growing lender competition and regulatory changes from Dodd-Frank.
Real estate fundamentals are improving across most markets and property types, which has prompted some lenders to be more aggressive on rates. Greater confidence in the recovery has also encouraged lenders to be more active in secondary and tertiary markets. Although some lenders are willing to go higher on leverage, for the most part, underwriting remains solid.
“We really haven’t seen the underwriting start to collapse the way it did the last time around,” says Stephenson. “I am optimistic that lenders can compete on rates without competing on underwriting.”
There is a bigger bifurcation emerging between CMBS and life companies. NorthMarq recently put a deal under application where there were five quotes—two CMBS and three from life companies. The CMBS quotes were about $7.5 to $8 million, while the life companies were offering leverage of $6 million and the rates were 80 basis points lower.
“You can either get dollars and pay for them or go low leverage and get a really attractive rate,” says Stephenson. “But we have borrowers who come in and think they can get the highest amount of dollars and the lowest rate and that just isn’t the way the game works.”
The CMBS market could be impacted by the Dodd-Frank “risk retention” rule that would require the issuer and/or the b-piece buyer to hold a bigger piece of the loan or the coupon on their books for a longer period. That is set to go into effect in 2016, but there is still some uncertainty on the reporting requirements and how they might impact lending costs. In theory, increased costs stemming from that regulatory change could be passed on to the borrower in the form of higher spreads.
The consensus is that the Fed will pull the trigger on an interest rate hike in December, with more modest increases ahead for 2016. However, the common view is that it is not likely to have a major impact on commercial real estate financing. It may create a bit of a pause as buyers and sellers try to find a new middle ground on sale prices amid higher interest rates. But, for the most part, capital markets have already factored that in and will adjust relatively quickly, says Katai.
“The key thing is that there is plenty of capital at all leverage points,” he says. “From where we sit today, all of the sources plan to show up in a similar fashion in 2016.”