April 2023 Capital Markets Recap

Tim Milazzo
May 2, 2023

Director of Inbound Originations Chris Peters and Director of Capital Markets Huber Bongolan recently went live to share a comprehensive update on the current state of commercial real estate capital markets. Follow us on LinkedIn to be notified about upcoming live events.

Press play below to watch the webinar: 

Not able to listen? Read the full transcript from the discussion here:

All right, good afternoon, everyone. Thank you for joining us today. Today is May 2, 2023. Welcome to our recap from the month of April of the commercial real estate capital markets. My name is Huber Bongolan, and I serve as Stacksource's Director of Capital Markets. I'm joined today with my co-host, Chris Peters, who serves as Stacksource's director of Inbound Lead Originations. We're going to start with and get into what's new and notable in the markets for the month of April. So to start, I'll pass it over to my teammate Chris to brief us on some news and events from last month.

Great. Thanks, Huber. Good afternoon, everybody. Good to see everybody. A couple of high-level noteworthy pieces of news this past month. Institutional Sponsors Defaults. Blackstone, Brookfield, and other institutional owners are facing loan defaults on office and multifamily properties in New York, LA, Chicago, and several other major markets around the country. Something to definitely keep an eye on as the years and quarter plays out. 74% drop in multifamily sales. Obviously, we're all feeling the lack of transaction volume and size and quantity of deals that are closing. This has been pretty significant. It's not only been felt in multifamily, but it's also in office, retail, and industrial. So we're definitely seeing a slowdown in sales activity. Most recently, over this past weekend, First Republic Bank failed, the second-largest bank failure in history. First Republic seized by JPMorgan, seized by the government, and then sold to JPMorgan over the weekend. And then lastly, rates. Rates have been coming down. They peaked in sort of the October, November of 2022, and we've seen them come down pretty significantly. Rates were down even further today. So it's definitely something we're going to keep an eye on. And Huber, I know you've been monitoring rates, so we'll dig further into the rates.

Awesome. So on this slide here, you guys may remember it from last month. So every single month we're trying to keep track of how rates are changing. Inflation is changing as well as Treasuries are changing here. So one of the welcome signs is that inflation continues to fall and continues to drop. You see that trend over the last couple of months if falling down here and as long-term rates. If you look at the Treasuries in two years, yes, it has been increasing, but this graph shows it over the last year to two years. One of the things that Chris had just mentioned in the last slide is if you take a peek at the right side, that last quarter, that last two months of data, you're starting to see the ten-year treasury as well as the two-year Treasuries start to look like top out and decrease and lower. So we're hoping that as things begin to move forward and progress in the year, that rates continue to tick downward. Here you'll see our slide on current commercial mortgage rates. While there are always exceptions to the rules here we've shown in the different rows, the different types of lenders that StackSource we are tracking daily.

And on the right side, you kind of see the upper bound and the lower bound of where rates are today per lender type. So of course there may be exceptions to the rule. There could be an incredibly hot lender that is giving an interest rate that may be lower than this or maybe vice versa. Someone that's ultra-conservative and has a higher rate. But as far as what we're tracking right now, here's where the typical lower and upper bounds are for rates today based on the type of lender that you're approaching for financing.

Yeah, and Huber that sort of leads us into our first bullet point here where we're seeing a really wide range of quoted interest rates. We're taking the same deals out, I'm sure other folks are experiencing this, taking the same deal out to a wide array of lenders and really getting back a pretty significant wide range in rates. You might bring a deal out and get something in the high fives, or low sixes and bring it out to a similar lender and get something in the mid to high sevens. This is really reflective of lenders' appetite for risk, how they typically price out a deal, potentially different leverage points or other factors that go into pricing a deal, but definitely seeing a wide range and really it's advantageous to bring deals to as many lenders as possible. Secondly, yeah, we're definitely seeing banks and credit unions tighten and or pause their either new originations or when they're underwriting a deal, becoming a lot more conservative. Obviously, on the first page we mentioned bank failures, I don't think this is sort of a one, two, three, and done for 2023. We're definitely going to see some more activity with banks around the country and lenders are going to be focusing on high-quality deals, high-quality sponsors, and strong markets potentially reigning in leverage just to keep things more conservative as they do underwrite deals.

Lastly, one thing we're definitely noticing is sort of two parts. We're noticing folks become a little bit more conservative in the CapStack, right? So senior lenders might be historically at 70-75 %, loan to value or loan to cost. We're seeing them reduce their leverage to 60-65 %. And this is really allowing for other folks to come into the cap stack such as LP equity shifting into a pref piece, right? Moving lower into the cap stack, becoming a little bit more conservative and a little bit safer in that part of the stack. There are other meds and other players that we can certainly bring into the stack and we're seeing it. But overall we're definitely seeing lenders and investors just become a little bit more conservative.

Sure, absolutely. Just adding to that last part. Yeah, I'm seeing it too with certain lenders, and when they get more conservative, more structured financing where you'll have to find those pref equity pieces or those mezzanine debt pieces to fill those extra layers of the stack. So very interesting to see that these LPs, these people that used to be very comfortable in a more limited partner equity position wanted to take a more secure spot in that pref equity or mezzanine debt piece. Nice. So looking into the months ahead, one is the first bullet point here. Bad is good to now bad is bad. What does that mean? Well historically I would say over the past maybe the end of last year, the first quarter of this year if we were to get bad news, we actually said, hey, that could be a good thing because maybe the Federal Reserve will start tapering and we'll start lowering rates. Maybe they will pause, or they will hit the pause button on their amount of increases. So that is the first part where initially, maybe last quarter of last year if there was bad news, we would indirectly think that might be good for us.

But now you're starting to hear the sentiment, seeing it more and more, especially in the news. I'm sure we're all feeling it, getting peppered with it in our inboxes. The bad news is now actually just bad news. The bad news might we don't know what it'll lead to. Will it lead to a deeper recession? Will it lead to decreased property values, more economic turmoil, and more job losses? How will Federal Reserve, treasury, and these institutions that we have in place, and how will they react to all of this bad news? These are things that we will be continuing to watch in the months ahead. Some of the news that we're starting to see now, the cracks that we're starting to see now that will play out, and again we're watching for months ahead are defaults fire sales, and workouts. They're slated to be about 270,000,000,000 of loans maturing this year. So in these challenging markets, the question to ask is what do you do when your loan matures? We know that we have higher financing costs that are making it harder for owners to refinance. These may lead, may lead, not necessarily will lead, but may lead to increased activity in defaults fire sales, and workouts.

Some of the things that I'm sure we're all seeing again hitting our news inboxes office assets, we're seeing them in big cities, whether it be San Francisco, my hometown, Los Angeles or New York City, and even Seattle. These office assets are posing the greatest risks. I think I saw recently a Costar metric that office vacancy is about 16% nationwide. So of course that'll vary from city to city whether you're in a major downtown area or a suburb. But overall that vacancy is at 16% and seems to be creeping up. So what is the hope? The hope is that if investors one is being able to refinance or sell successfully, but if not, then if it does lead to some type of loan default, these loans will be able to be restructured. There will be some type of extension in order to prevent a foreclosure or a fire sale. And then lastly, you see here that the last debt is floating rate debt refinances. So investors with floating rate debt that they may have got into two years ago or three years ago that are coming due, we talked about that wall to Maturities, I'm sure you've all seen it.

What are they going to do now with the potential to refinance? But those refinances are looking at rates maybe three to five times higher than what they were expecting. So what are the solutions for some floating rate debts that are coming due? So those are some of the things that we're tracking in those months ahead. But StackSource is absolutely here to help. So tell you about us. I'll pass back it over to Chris.

Awesome. Thanks, Huber. Yeah. For those of you that don't know us or need a quick refresher, we're a group of expert capital advisors, sourcing debt and equity across the country. We work with about 1000 unique capital sources banks, credit unions, life cos, debt funds, private equity, family offices. We've closed about a billion and a half of financing across 45 states. We really do pride ourselves on being transparent both in our process as well as when we work with lenders providing full transparency. So if you guys have any questions on our business or what we do, please don't hesitate to reach out right now. We will kick it over and look at some questions that are coming in from some new folks. You can always reach us at hello@stacksource.com or go right to our website at www.stacksource.com and we'll look at some questions to get us started. Let's see here. Okay. All right, first question. What are some of the challenges associated with this goes right to your last point. What are some of the challenges associated with floating-rate debt refinances and how can commercial real estate investors prepare for them? Huber? I can start it and then feel free to chime in.

Yeah, it's a tricky environment. With floating rate debt, we've seen prime go from three, three, and a half to eight, potentially eight and a quarter tomorrow. If they do end up raising rates, we've seen Libor or now SOFR jump 400 basis points. So it's really difficult. Obviously, we're hearing cash in refinance and I think we've talked about that a couple of months in a row now. Yeah, it's definitely challenging. People, investors, and advisors have to get creative on how to sort of recreate a capital stack when it's time to refinance or restructure a deal. So I think getting creative, and finding alternative sources of capital to fit into the stack because right now senior debt may not cut it. And if you're refinancing out of a bridge or construction loan and you are projecting a certain amount of rent increases or a certain amount of value creation and it's not there. You really do have to get creative.

Sure. And jumping into that last part of how can commercial real estate investors prepare for them for these maturities? A couple of things that I'm seeing. One is lenders being more open to what we call bridge-to-bridge financing. So let's say you're in this floating rate bridge debt scenario. Your loan is coming due and you've tried to get perm financing, but those rates are just too high for you right now to digest. There's kind of two options here that I've seen be successful. One is are you fully stabilized or are you still stabilizing and you need more time? Or maybe there was a certain cost that you think could yield more rent premiums for yourself. Finding another lender, that would be a bridge takeout. We're starting to see more lenders being open to bridge and that could buy you another one to two years of interest-only payments as you wait for markets to stabilize. That's one potential option. Another one that I've seen is if your deal does pencil, but yes, it is a higher rate, but your deal does pencil and you're able to get that perm takeout, then one thing to look for, to negotiate is a soft to no prepay penalty.

So the reason to negotiate for that is when and hopefully rates start to come down, start to stabilize, start to bring them down. Then you're in a position where if you have a soft or no prepay, you could seek a refinance with that current lender going back to them or searching back around and bringing your deal back out to market. And you won't be penalized with a stiff prepayment penalty, whether it be step down or defeats or some type of minimum yield. Right. Trying hard now to negotiate for those soft or no prepays could be another strategy that you take if you're in a floating rate debt scenario and you're starting trying to refine to a perm situation.

Yeah, good point. Huber in one thing, it's sort of funny to hear from lenders, but we're hearing if you get a deal, take a deal. Right? Because that deal may not be there tomorrow or the next day when you're trying to improve certain terms. So in this environment where even getting a deal is challenging, if you do have one in hand, it probably makes sense to take a deal and then sort of regroup and figure out how to get a better deal six to twelve months down the road.


Excellent. Moving on to the second question. How does the trend of investors seeking safe havens lower in the capital stack impact the types of deals that are currently available in the commercial real estate market?

Nice. So we touched on that earlier with maybe players that used to be very comfortable being in an LP equity position, wanting more of a prep equity position. I would say the answer to this is maybe more structured financing. Like, the deal is just because maybe you go out for a perm senior loan and you needed 75%, which was stomachable maybe a year ago. Now they're down to maybe if they were down to 65 and oh my gosh, where's that 10% going to come from? I'm stuck now. It's not over. There are pref equity players or mezzanine debt players. So I think that this trend of investors seeking safer havens, even if your senior loan was now lower, allowing for only lower leverage, you could still fill that in with different parts of the capital stack, whether that be pref equity or mezzanine debt, or even if you're in a construction financing, we're seeing a lot of deals. Include or consider including C-pace, which is another form of gap financing a little bit more structured. But we're happy to tell you more about C-pace. If that's something you're interested in, just reach out. But we're starting to see these other kind of lenders come in and being able to fill in the gap.

Yeah, and I think one thing to add is there lenders that aren't beholden to regulators or audits or the extent of audits that a bank or credit union might have, you know, they've got a lot more flexibility on what they can do, who they can work with. So looking at private lenders or debt funds that might have an opportunistic bucket, just as Huber said, and can maybe do a senior loan and mez or prep or something unique and structured that gets the deal done and sort of moves the investor on to the next phase is something we're definitely seeing. All right, let's see other questions coming in here. What are some of the key factors that commercial real estate investors should consider when assessing the risk of default, fire sales, and workouts? I think I can start this. Huber communication is key, right? If you are an investor and you have a loan coming due or you're tripping certain covenants, communication with your lender is key, right? If you've been sort of hiding and don't want to have the tough conversation of where are we at? How are we going to pay our debt service? It's going to be a tough discussion when you actually do meet with your lender.

But in our experience, keeping lines of communication open and having discussions being sort of open and honest with your lender can go a long way. Right. A lot of these lenders don't want to foreclose on a property. They don't want to have to take that property out to market and sell it. They're not in that business. Right? So having open lines of communication, and figuring out a way to find a solution that is amicable to both the lender and the investor is ideal. Right. Nobody wants to be in the situation when they get themselves into it. But as long as you're communicating with your lender or the other investors in the deal. That really does go a long way.

Chris, I think you nailed it. I'm in that situation right now with one of my clients where I'm helping them through a workout situation, and that communication is key, especially knowing your timing of when things are happening. When it comes to that, check your loan docs over what happened with the timing here. How would these things work out? Maybe you want to engage legal just to make sure that you're understanding the timing of processes correctly. But the lender, for the most part, does not want to take the property back. Usually, they're not in the business of owning property. They're in the business of financing. So trying to find a way, as Chris said, having open communication, trying to find a way for a solution that works for both parties, that's going to be ideal as everyone works through these next couple of months.

Awesome. Looks like we have time for one more question. This one is back to rates. How do the recent changes in interest rates impact the underwriting and deal structures of commercial real estate loans?

Sure, I'll jump in on that one, Chris, and then, yeah, if you have more to do for that one, it depends on your time. Right. If you're looking at the trend, that longer-term trend where rates are higher now, then, of course, it's going to have a constraint on your DCR, on your debt service coverage right there. And that might have to be a negotiation with the lender or with a new lender. If you're seeking new financing, I think that the hardest one is the DCR ratio is getting that pulled back in. But if you're looking at over just the past 30 days, 60 days, as you had mentioned, Chris, in your slide earlier, about how it's gone down, some of the treasures have gone down the past, then if that trend continues, that should be a bright sign for a lot of our investors. That should make it easier for people to refinance and get the proceeds that they need if that trend continues of rates going down.

Yeah, and I think the only thing to add there is, from a lender standpoint, it's just understanding what the risks are and how they price a deal. Right. Three, six months ago, there was a lot of scary noise out there and inflation was still increasing, and we were sort of starting out the upward trend in short-term rates. So there was just a lot of unknown. I think the more that lenders get comfortable with the risks and they sort of understand where the market's at. That spread that we mentioned earlier, that wide range between lenders, in my opinion, that's just a function of different risk tolerances and sort of not knowing where we're at. I think as more comes to light and we figure out the real direction of inflation and how high we need to increase rates or how long we Need To Keep Them At This Level to really Bring Down Inflation. The more we know, I think, the easier the financing side will be.


We'll get more intel from our lenders.

Nice. Absolutely.

All right. Well, that concludes our capital markets update for the month. Again. If you guys have any questions, please reach out to us. Hello@stacksource.com or www.stacksource.com. Hubert is always a pleasure.

Absolutely. Thank you, Chris. And thank you, everyone, for joining us today. And we look forward again. Reach out. Here's our information on the screen. Any questions, we're here to help, right? It's a trying time, but we're here to help. And we have a lot of experts on our side, a lot of big teams that can help out with any of the issues that you might be dealing with today. So with that, we're looking forward to seeing everyone at our next recap a month from now. Thanks, Everyone.

Thank You.

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