Robert Slatt
In a volatile market, communication is key. Communication between borrower and servicer to navigate a shifting rate climate and new workstyle realities. Communication between borrowers and their commercial mortgage banking advisors who offer perspective, guidance, and options on new loans and refinancing. But the communication that is perhaps most important in my world right now is between lenders and their correspondent advisors and loan production originators like me who directly meet the market and apply their loan programs to qualifying assets and vetted sponsor
This year’s Mortgage Bankers Association 2023 Western States CREF conference was thus a timely opportunity for lenders to gather with their correspondents and advisors to talk shop and align perspectives moving towards Q4 2023 and into next year. There was a shared sense of optimism that overall economic health will remain strong and buoy the general economy as CRE grapples with a new rate climate and shifting fundamentals. The focus was on near-term priorities, long-term expectations, and new business that will get done in the months ahead. Here’s a quick update from this conference attendee on what the general themes driving commercial mortgage and related finance are as we move into the final months of 2023.
Lenders and Programs
The most compelling buzz at the conference was the conversations around lending programs expanding to offer mezzanine financing, preferred equity, participation loans, or other novel products to decrease capital cost. Equity is abundant yet patient and waiting on the sidelines to transact at the right basis, office assets included. Rescue capital exists in these offerings, and sponsors will have different programs to access depending on need when the time arises.
Life companies remain the most active and competitive capital source in the market. However, they are becoming more selective due to both caution and high demand caused by lack of competition. Some have construction to perm, transitional/bridge (fixed and floating), and participating programs. These participating programs act like preferred equity and mezzanine but are a novel way for sponsors to optimize their financing with no additional equity required.
Many debt funds are having their busiest year ever and the banking pull-back has caused a flood of deals to move their way. However, not everything fits their model as most are still underwriting loan proceeds to a realistic take-out at the end of the business plan. Some are engaging borrowers in work-outs for loans arranged on properties in the last two to three years where the business plan may not have come to fruition, project costs or floating rates have increased, the sale market is not active, or a realistic conventional payoff is not available.
While agency pricing has drastically increased throughout the year, the GSEs are still offering an attractive and flexible financing solution for multifamily. Decreased transaction activity has resulted in both agencies currently achieving only 35 percent of their 2023 allocation goals. This has encouraged Increased interest in short-term lease-up deals that are expected to stabilize in three to four months from a closing. Interest-only terms are still available but, due to the inverted yield curve, this will have a minimal effect on overall spread.
The conference was not well attended by banking, credit union, and conduit lenders. Turmoil in the banking sector in 2023 caused a pull-back from lending into the market across the sector, taking a risk-off approach by shoring up liquid reserves and focusing on their existing clients. In this way, banks remain available to their best depositors and competitive for their patronage. While credit unions do not seek a depository relationship and can offer flexible prepayment structures, their programs are typically recourse with rates at the high end of the conventional lending spectrum. They are active, but certainty of execution can be quickly upended through closing by changing credit perspective. CMBS has struggled due to rate volatility, underwriting complexity, and cheaper alternative capital sources still active in the markets.
Rates and Duration
Life Companies remain active at spreads ranging from 1.80 percent to 2.30 percent over the UST for their permanent debt, with spreads ranging from 1.40 percent to 1.80 percent over the UST for select low-LTV Class-A multifamily, industrial, or grocery-anchored retail deals above $10 million to 15 million.
At the agencies, spreads are currently in the 1.40 percent to 2.20 percent range over the UST, with the best pricing on low leverage and affordable projects.
Debt Funds are offering preferred equity and mezzanine programs, but for many this may be cost prohibitive at 12 percent to 16 percent rates. These loans also raise equity dilution and refinance issues concerns for many. Typical bridge loan rates have a range of 8 percent to 12 percent fixed, or SOFR-plus 3.50 percent to 7.00 percent.
That said, increased rates are still trickling through the financial sector leading to maturity distress. Loan workouts and extensions are beginning to kick in and we will see the pace picking up into Q1 2024. While the industry may hope that interest rates will decrease soon, there is a high likelihood that unless macro volatility suddenly exits the market, this may be the new rate climate normal for at least the near-term, and most likely into the mid-term of H2 2024.
Hope this helps inform your capital markets strategy for Q4 2023. For those of us who have been through some cycles, we know that best practices are defined through communication and collaboration during periods of market disruption and dislocation.
Robert Slatt is principal, Gantry.
