Q4 Capital Markets Update
published Oct. 3, 2023
Lenders Pulling Back
It has been a multi-year run as a "Borrower's market" whereby substantial Borrower-friendly loan terms could be negotiated by creating a competitive market. The tides have turned and it has largely become a Lender's market, with a wall of maturing loans through 2027 up against banks and other funding sources stepping out of the market or substantially lowering their exposure.
Liquidity requirements have increased, up to as much as 30% of the loan's balance. The larger focus today is on sourcing lenders who will provide certainty of execution, ideally on balance sheet, and not re-trade on terms from minor items that may come up in 3rd party reports or at the property.
As CLO bridge and CMBS continue to be "lenders of last resort," many of the banks and credit unions are asking for large deposit relationships and/or underwriting much more conservatively based on historical collections and expenses as opposed to current scheduled income and market expenses. Today, it is imperative to address any possible re-trades or issues that could arise before signing a Loan Application. Lenders are looking at Borrowers more holistically; digging into other property financial performance, near-term maturities, any floating rate debt, and global debt service coverage ratios.
Finding the right Capital Stack
As short-term index rates remain high, bridge loans remain challenging to underwrite. An alternative that we have found compelling under the right deal profile is layering Preferred Equity behind a Senior permanent loan. This is working especially well behind Agency loans on lighter value-add deals, albeit there are plenty of complexities to navigate.
The chart below lays out an example of the high-level math today versus a traditional Bridge loan. The Senior plus Pref translates to a blended current fixed rate in the mid-6%’s, with the blended total rate (including the Pref’s accrual component) in the low-7%’s. This compares to bridge rates in the ~9%'s, not to mention the additional costs of a SOFR Cap, and CAPEX and interest reserve holdbacks. A couple of the negotiating points on the Pref Equity include the treatment of depreciation and the language and structure behind repayment guarantees.
Rate and Economic Indicators
10 Year Treasury up to 4.67% sitting at a 15-year high! The forward curve is pinning the 10-year in the high 4%'s for the next several years.
Term SOFR up to 5.32% and expected to start its' slow decent in Q2 2024: SOFR forward curve predicts 4.0% by Q3 2025 and falling further from there.
Unemployment Rate: 3.80% compared to 3.50% last month.
Core CPI: 3.9%. Lowest level in two years and down from the 6.64% peak one year ago.
So will the Fed be cutting rates anytime soon, given the latest data?
While the economy is contracting, a small recession will not necessarily drive the Fed to cut rates. The start of a rate cut would likely be driven by one of the following:
1) Financial instability, whether led by more systemic banking issues or large lack of liquidity in the market.
2) unemployment shooting up.
3) inflation on the reliably clear path towards 2%.
Signs are pointing more and more that rates may stays higher for much longer.
Rates: Soft pay ~7.0% with total accrual rate +/- 12%
Property-Type: Multifamily, with other property types considered on case-by-case
Geography: Nationwide Primary and Secondary markets
Pref Size: $2 million - $7 million
LTV: Up to 85% of purchase price, 75% of total cost
Term: 3 - 6 Years
Prepay: 2 or 3 year minimum return
Recourse: Both Recourse and non-recourse
Nevada City, CA
$4.20 Million Cash-Out Refinance
No Prepayment Penalty
Fannie Mae & Freddie Mac have become one of the most reliable sources of capital in the market today. Buydowns have remained an accretive solution to increase loan proceeds by 2-3%. They have increased their liquidity requirements to 20-30% of the loan balance.
Life Companies have become increasingly selective. Many are not quoting. There are some options for well located real estate, early rate locks, and pre-stabilized assets in lease-up.
Banks and Credit Unions have pulled back further. Many are requiring heavy deposit relationships in return for making a loan. Credit Unions have remained a great option for flexible prepayment terms.
CMBS remain the "lender of last resort" with high investor spreads and generally lower leverage.
Bridge Lenders have become hesitant in many top markets like Phoenix and Dallas, where they have exposure and existing issues in their portfolio. There are still groups hungry to place capital, but the underwriting assumptions need to make a strong case for it, with stabilized Debt Yields often in the 9%+ range.
Construction Lenders are being extremely selective, with focus on either existing relationships, or experienced Sponsors with very strong deal and market fundamentals. Leverage is generally lower around 60% LTC. FHA remains a competitive option with construction loans that convert to 40-year amortizations with rates in the low to mid-6%'s.
6.20% - 7.0%
LTV & DSCR dependent
7.10% - 7.60%
LTV & DSCR dependent
6.0% - 6.60%
not including MIP
5.80% - 6.40%
Bank, CMBS, &
6.20% - 7.20%
DY & term
8.50% - 9.75% +
Spreads of 3.30%+
LTC & stabilized DY dependent
7.50% - 9.25% +
LTC & size
Food for Thought
A macro look at industrial supply and demand:
Every extra $1B of E-commerce sales equates to roughly 1.2mm SF of industrial space needed. Current E-commerce is ~16% of total retail sales at over $1T and expected to nearly double by 2025, which means there will be a need for another roughly 1B industrial SF by 2025.
Tim Gerlach, CPA | Principal
CPA Lic. 130463 | Broker Lic. 02038912