Sponsored by CoStar
By Justin Bakst
Yogi Berra once famously lamented, “the future ain’t what it used to be.” As we examine the 2017 commercial real estate debt markets and look to the remainder of the year, Berra’s words ring true. Leading up to the election there was a pause in the market, but most lenders are now reporting a full pipeline. On relative basis, debt volume growth is slowing after the surge experienced over the last several years. With volume declining, many lenders feel like they are on a treadmill, with new production being offset by payoffs and amortization. Despite the recent interest rate hikes by FOMC, rates are still at historical lows and the yield curve is flattening, driving lender behavior in the search for yield.
Competition continues to be the biggest challenge facing lenders. Bank and insurance companies continue to grow their portfolios, which now account for 75 percent of lending. Alternative debt sources have entered the market to address funding gaps, specifically as construction volume has slowed given uncertainty around high volatility commercial real estate criteria.
Are We Overleveraged?
As we look towards the remainder of 2017, its useful to examine the current debt cycle in relation to historical levels as measured by commercial real estate debt outstanding to GDP. Despite concern cited in some media, most do not consider the current environment to be excessively leveraged. In the face of tightening spreads, increased regulation, and the prospects for rising interest rates, outstanding commercial real estate debt to GDP will continue to rise higher above its long-term equilibrium.
In relation to outstanding debt, sustained low delinquency rates speak to the stability of the market. Even with unprecedented amounts of CMBS maturities in 2015, 2016 and 2017, from vintage loans and “the wall of maturities,” defaults have been much lower than expectations. Delinquency rates remain low. Excess multifamily supply in Tier 1 markets and the potential for retail closures still remain at the forefront of lender concerns, but we expect credit quality to remain strong throughout the remainder of the year.
Strong property values should continue to drive volume and credit dynamics. Lenders appear to have learned from the past, and most would say we are in the seventh or eighth inning of this cycle, with some property types and markets showing frothiness. Across all property types, prices are at historical highs, far surpassing prerecession levels. In fact, multifamily prices are 31 percent higher than the prior peak in 2007. Prices are forecast to only slightly increase through the remainder of 2017.
Barring an unforeseen political event or economic shock, the last half of the year should experience a rebound in overall debt market volume with credit quality remaining relatively unchanged. But as Berra once said, “little things are big.” A warning to both lenders and investors: We are too far into the real estate cycle to take outsized risks.
Justin Bakst is is the director of capital markets responsible for CoStar Risk Analytics platform where he focuses on analyzing and connecting commercial real estate lending dynamics utilizing CoStar Group’s products.
Learn more at www.costar.com.