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What to Expect from the Debt Markets in 2017

What to Expect from the Debt Markets in 2017

This is a good time to be a borrower, according to Jeff Erxleben, executive vice president and regional manager in the Dallas office of real estate debt and equity provider NorthMarq Capital. All types of capital providers—banks, insurance companies, conduit lenders and private equity funds—are actively looking for deals, and loan terms continue to be attractive, even if loan-to-value (LTV) ratios have not moved much above 65 percent.

But while capital markets look set to have an active year in 2017, borrowers should keep in mind that lenders are gradually becoming more conservative as the we get further and further into the cycle and as interest rates are projected to rise.

NREI spoke with Erxleben about the current financing environment and the outlook for the rest of 2017.

NREI: How would you describe the current financing environment? How does debt availability compare to the same time in 2016?

Jeff Erxleben: I think when you compare to 2016, the market is still strong. There is still an adequate amount of liquidity from pretty much all capital sources on the permanent debt side. Construction lending is still difficult to get done. I think that’s very similar to what we saw in 2016. Multifamily remains a favored product type, although there is a significant amount of construction really throughout the country, and leased industrial is probably the most favored after that.

NREI: Is anyone doing construction loans? If so, what types of assets are those lenders favoring?

Jeff Erxleben: Where we have seen the activity on the construction lending side has been with the middle-tier banks. They seem to be the most active [in that space] and really stepping up into those loans. The bigger banks seem to be less active. I think there [are]probably a number of things at play here—one is capital ratios coming out of regulations and another is how construction loans are treated internally. And it’s exposure as well—there’s been an active construction cycle for many years now, and the big banks are probably reaching their limits on that. The middle-tier banks have less exposure and are therefore able to accommodate those loan requests.

NREI: Who are the most active lenders on the permanent loan side today?

Jeff Erxleben: In terms of overall activity, on the multifamily side, it’s clearly the agencies. Freddie and Fannie are very active. Other permanent lenders that are very active are the life companies. They are starting out 2017 with new, robust allocations, similar to what they had in 2016, but they are at the beginning of the year.

NREI: What types of assets and markets are permanent lenders targeting?

Jeff Erxleben: Multifamily is still very much in favor, grocery-anchored shopping centers are very much in favor, industrial is very much in favor. Most markets are perceived as performing very well, even secondary markets. Some energy-depended markets—Houston comes to mind—will require more conversations. There is still capital available, but it’s just a smaller group of lenders compared to Dallas or Los Angeles or another market like that. Some markets have selective softness—for example, San Francisco is softer on the multifamily side—but there’s still capital available in those markets. It’s just at times more challenging to get.

NREI: Last year was a challenging one for the CMBS market, with issuance falling below the industry’s expectations. What do you expect to see in the sector in 2017?

Jeff Erxleben: We look at CMBS and the immediate snapshot for today is that the terms they are offering are improving, the process they are offering is improving. Pricing is coming down. So overall, CMBS looks to be improving from what they were offering in 2016. In 2016, they weren’t offering products that were as attractive, and the other side was the servicing. At least from what we are seeing now, they are doing significantly better than they were in 2016.

NREI: We have a significant volume of CMBS loans maturing this year. In 2016, not all of those loans were able to secure refinancing. What’s your outlook on that for 2017?

Jeff Erxleben: I think private equity is going to play a big part in that. You’ve got an environment from the end of last year to today where the underlying Treasury yields have increased, and the rates are now higher. That’s where I think private equity groups are going to come in and help make those monetizations work. The good news is that there are a lot of groups who are looking for those deals, you are just going to have that extra piece as opposed to a simple refinance.

NREI: Speaking broadly, what kinds of terms can borrowers hope to get right now?

Jeff Erxleben: If you were looking at a multifamily project, a moderately leveraged 10-year fixed-rate loan (by moderately leveraged, let’s say it’s at 70 percent), would be in the mid to low 4s. If I had to pick a specific number, it would be 4.25 percent. If you wanted to tighten it to a five-year loan and 60 percent LTV, the interest rate goes to 3.5 percent and, in some instances, lower than 3.5 percent.

Probably the biggest difference we see between multifamily and commercial transactions is less coupon-driven and more LTV-driven. On commercial transactions, you are limited to LTV of 65 percent, whereas on a multifamily deal you can go to 75 or 80 percent. The coupon yields themselves are at times different, but not by that much.

One of the things we have definitely seen since the rate increase at the end of 2016 is spread compression. It’s a competitive environment.

NREI: This cycle has lasted longer than average and property values still seem to be going up. How is that affecting lenders?

Jeff Erxleben: I think that from a lender’s perspective, when you look at this cycle and how long it’s been going on, you are going to be more conservative in 2017. Specifically, when you look at projects that have increased in value merely because of cap rate compression, lenders are not going to lend on short-term cap rate compression.

You really have to have projects that have increased in value because the underlying fundamentals have improved. Elements like full cash-out on projects are going to be more challenging in 2017. Overall, I think there is a good possibility of a cooling throughout more markets. Property economics and fundamentals are not necessarily weak, but there would definitely be less growth or flattened growth as opposed to previous years.

NREI: What advice would you give borrowers looking to secure a loan in 2017?

Jeff Erxleben: The advice that I would give is there’s ample liquidity in the market today, so it appears that financing your project sooner rather than later, when there are active market participants, seems to be the best course of action. I don’t see anything in my forecast that would say that things are necessarily going to change. However, with any debt market, historically it’s better to financer earlier in the year, especially with the life companies, while they are still looking to put money out.

NREI: What might be some challenges that the debt markets might face this year?

Jeff Erxleben: If I had to sit here and say, “What is an unknown?,” there is always the possibility of some unknown regulation coming into play from the new administration. That is an unknown thing that could potentially come down the wire.

NREI: The new administration is already moving to dismantle the Dodd-Frank regulations. Yet we’ve heard from some sources that it may not be what the commercial real estate financing industry wants to happen at this point. What is your take on how an overhaul of Dodd-Frank could affect the market?

Jeff Erxleben: I think there has been a large number of groups that have positioned themselves to accommodate risk retention and to comply with the rules. In the CMBS market, some of the issues they had in 2016 were related to the transition. I think it would be very difficult to just do away with it at this point in time, although there some concerns surrounding the new rules. I believe that although there will be changes done to it, it will probably be done over time, as opposed to overnight.

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