February 2023 Capital Markets Recap

Tim Milazzo
March 13, 2023

CEO Tim Milazzo and Director Chris Peters 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:

Welcome to the February 2023 recap of what is going on in the commercial real estate capital markets hosted by StackSource. I'm StackSource founder and CEO Tim Milazzo. And I'm joined by my colleague, Director of Originations Chris Peters. And we're going to get into what's new and what's notable in commercial real estate finance. And without further ado, let's go for it.

Awesome. Great to have everybody back this week. News in the market. Obviously, rates are on everybody's mind. The treasury rates are up 40 basis points. Both long term and short term. Treasury yields are rising quickly, approaching the highs that we experienced in the latter part of 2022 and really erasing a lot of the optimism that we saw in the early part of January and February of this year.

Yeah, and there's trouble in the New York City institutional market. So if you're watching commercial real estate news, you'll note that names like Blackstone, Thor equities and other famous institutional commercial real estate investors are having trouble with their New York City properties, either defaulting or sending loans to special servicing for both office and multifamily properties in New York. And this is a trend that has accelerated in February after seeing a couple of the first special servicing and default moves in January.

Jobs. Jobs have been on people's minds as well. Sort of some conflicting information here, but job support actually showed more than half a million jobs added in the economy, strongly beating expectations and really a major reason why the Fed is going to continue to push rates higher for longer.

Finally, on the residential mortgage side, there's been a number of headlines about residential mortgage rates getting back up into the 7% range. This corresponds with what Chris just mentioned about Treasuries being up 40 bits during the course of February. So Redfin reports that mortgage demand for consumers is at a 28 year low due to mortgage rates rising so quickly.

Rates, we just touched on treasury rates. We can start actually at the top with inflation. The report is due out next Tuesday. But the most recent report showed inflation basically flat as it was in January. Obviously, we're hoping inflation comes down, but we'll be monitoring that and giving an update on that next month when the new report comes out. As far as Treasuries here, you can see the ten year and the two year, they've increased pretty sharply. Like we mentioned on the previous slide, the ten year is up 40 to 50 basis points. The two year is actually the highest it's been since 2007. And one metric that we look at is the two and ten year spread. So essentially the difference between those two rates, as everybody knows, rates are the yield curve is inverted and that spread is now about 100 basis points. So there's a 1% difference between the two year treasury and the ten year treasury term. SOFR, you can see it, it's just underneath the two year treasury. It's basically flat from where it's been in January, but we're certainly expecting short term rates to continue to increase right.

And moving on to commercial mortgage rates and what that means for your actual borrowing cost. As a commercial real estate investor in the market today, in the first week of March here, we expect the best deals for strong sponsors and with low leverage to be quoted in the mid to high fives, so that can be non recourse through agency or CMBs. And some of the most competitive banks and credit unions would be giving rates in the fives today. But it's not going to be for full leverage deals and it's certainly not going to be for deals with any hair. Most deals are getting quoted in the sixes, if not sevens even on quality assets with some cash flow, leverage has been pulled back based on debt service coverage ratios. When rates go up to these levels, when we're looking at construction transitional bridge loans deals with any hair, the rates can go up further from there. Starting in the sevens, debt funds that are providing more entrepreneurial bridge loans than what would be financeable with banks or with non recourse options. They're going to be starting just right around the nines today and can go up sharply from there.

I mean, we're seeing very legitimate private debt funds quote deals at 13% and it's not unreasonable for them to do so. And so rates are certainly up on commercial mortgage quotes versus a couple of months ago. This corresponds with the rise in both Treasuries and Term so far. So it's really short term and long term interest rates and quotes of commercial mortgages have been up in the last few months. So as far as deal structure, because we know that rates are up. So what's happening with deal structure and leverage in the market? Some of the largest banks and credit unions we had reported in the last couple of months have started to reduce leverage or pull back from certain commercial real estate lending scenarios. There have been an increasing number of banks and credit unions following suit at the regional and community level at this point that we've seen in February. So it's not just big name major banking institutions, but pockets of banks and credit unions across the country at all sizes have really pulled back either their maximum leverage or they're being debt service constrained. But even more prevalently, they're pulling back from quoting as many commercial real estate deals that aren't a perfect fit for their programs, meaning that to get a bank or credit union quote is requiring going to more commercial banks and credit unions to solicit quotes today versus a couple of months ago.

Life insurance companies who usually do shine on Class A properties, especially with lower leverage. It's still their time to shine because their cost of capital is not as closely tied to these market swings as some of these other lenders that are quoting rates based on Treasuries. And so not only the best rates, but many times the best terms are being provided by life insurance companies today, especially on Class A properties, especially in gateway markets and with reasonably low leverage, it certainly is their time to shine. Some life insurance companies are quoting full recourse and some are non recourse. Finally, CMBS non-recourse lending volume is down. Overall, it has low start to the year, but the product is currently competitive on a non recourse basis for hospitality for retail and medical office. Once again, on a deal by deal scenario, leverage will max out based on either debt service coverage or debt yield. And so speak with a qualified capital advisor to get a specific quote or insight on a specific type of deal. But these are what we're seeing in general.

Yeah, Tim, and the only thing I would add for good deals, good locations, good sponsors, there's still great deals out there and there's unique structures that we're seeing that are advantageous to either acquire a new property, construct a new property, or refinance a new property. And as we mentioned last time, we're focused on prepay penalty. That's one key item that we could use to our advantage to either acquire a deal, develop a deal, or refinance a deal, but give us some flexibility on the back end when rates do come down and we can get into a lower rate loan.

So Chris, what are you expecting for the months ahead?

Yeah, it's all about the economy, right. Major thing, investor optimism that interest rates were going to quickly drop back to historic lows has waned pretty significantly. Sentiment is shifting to quote unquote, higher for longer. We've seen that in the news. The Fed actually came out, chairman Powell came out today and said ultimate level of interest rates is likely to be higher than previously anticipated. That shook the market. You could see that the stock market was down percent to quarter, percent to half today. Yeah, I think the reality is rates are really going to be higher for longer. And that goes right into the second bullet point. The Fed is hinting at raising rates 50 basis points versus the most recent increase of 25 basis points. Just a refresher, there's been eight hikes, 25 basis points, 50 basis points, and then four hikes at 75 basis points, back down to 50 basis points and then reduced to 25 basis points. So yeah, we could certainly see it jump back up to 50 basis points. And I'm many market participants are expecting it, so we'll be watching for that. We'll be watching the jobs report this Friday and then the inflation report next week on Tuesday.

Yes, and the increasing Federal Open Market Committee decisions on increasing the fed funds rate. This is most clearly and directly impacting short term lending rates. Lenders that are offering bridge loans and construction, we're expecting those types of interest rates to continue to rise. So we do see some developers trying to race to the finish line to get deals ready to be funded and finish their due diligence before these interest rates continue to creep back up before their closings. Excellent. Well, if it's your first time with us, we're StackSource. We are a team of expert capital advisors providing debt and equity financing solutions for real estate investors in their capital. Stacks we have a nationwide reach with closed loans in 45 states. We've arranged about a billion dollars and half of financing across the country at this point. We provide competitive terms so that you get the right fit for your deal scenario, and we do all that with transparency. A web platform that shows you here are the lenders you're matched to, here's the fee structure, and you can see exactly what you're matched with in the capital markets and what's going on as we bring you out to market to get quotes.

So as rates are up, as deal structures shift, making sure that you're getting the best financing quotes on the market is what we are after. Without any further commentary, we'd love to see if questions are coming in on the comments on the various social media platforms. We have a couple of questions that have come in ahead of time, which I believe you have access to. Chris?

Yeah, we have a couple of questions that came in, but again, if you guys have any questions, please fire them in. First question is, with banks and credit unions pulling back on commercial lending, what alternative financing options are available for developers and investors and how do these terms compare to more conventional financing?

I certainly will lend my perspective on this. So, banks and credit unions are one of the major food groups, so to speak, of commercial real estate lending. And we're talking specifically for senior loans, which is usually the majority of the capital going into any deal. And if we're talking developers and investors with major value add or redevelopment plays, there are a number of other capital markets solutions out there. Some of them are other lenders that will be private lenders, private debt funds that can be more entrepreneurial in their underwriting, they can be more flexible, they are less regulated. Working with debt funds that have a captive pool of capital specifically for transitional and development assets is certainly an option. There is a lot of dry powder in that space. There are a lot of debt funds that are ready to go for strong sponsors and strong deals right now, if they're in, it the right basis. Now, I don't think that's the end of the question to say, oh well, banks and credit unions are pulling back. It's all about the debt fund. Certainly that's part of the solution. But many deals that we're seeing today, the way to get that deal to pencil out and be pushed through and to have the capital it needs to be successful.

You may start with a debt fund, you may even go with a bank that has pulled back their maximum leverage. But there may be a gap in your capital stack. And so we're increasingly seeing explorations into preferred equity. So tranches of capital between the sponsor developer and the senior debt, quote so mezzanine debt and preferred equity. We're seeing an increasing amount of investors open to exploring C pace financing, ground lease buying is an active market and has become of interest. So there are these other capital markets mechanisms and other alternative capital providers that are becoming more and more prominent. So certainly debt funds, but also mezzanine lenders, preferred equity, tranches have become front and center for developers that would not have considered using such sources of capital maybe a year or two ago.

Chris yeah. No, I agree. Tim One thing we've certainly noticed is, like you mentioned, folks looking for other forms of capital. And in our network of capital sources, we've certainly had debt funds or private lenders that have come to us and said, hey, we have this opportunistic bucket of capital. We don't really advertise it, but here's what we're looking for. And it sort of fits that mezz or Pref or, you know, LP or Co GP equity. So you know, that, as Tim said, there's certainly dry powder out there. Those capital sources are looking to get creative. You know, they understand that that sometimes a senior loan may not pencil at 70, 75%, let alone 80%. So they'll sort of fill that gap. But yeah, I agree. And it's unique that it's coming from both the investor and developer community that wants other capital to fill the stack. And then our capital sources are saying, hey, we have this other capital, let's put it together. So it's sort of a nice match in today's market. And that sort of answers. We had a question come in. Where does that mez and prep come from? Debt funds, private lenders, family offices, other institutional investors generally fill that gap.

Moving on to a second question that came in. How have recent defaults and special servicing of loans for office and multifamily? So just as we mentioned in the first slide, how have these defaults and how have they affected investor sentiment towards these asset classes? And what does that mean for the broader commercial real estate market? Tim, I can sort of take the lead there and feel free to chime in. Yeah, obviously office has been tough. Those of us that work in an office or go into a major metro, we know from three or four years ago, streets are less crowded, trains are less crowded, public transportation, subway. If you take a subway, those are less crowded. Who knows if that will turn around? But office is definitely a risky asset in today's market. It's not just the Amazon effect and that's a little bit more retail, but it's not just the Amazon effect. It's not just COVID. Hybrid working is a big movement and so it's definitely impacting the office market. Multifamily, we would probably see that more as a recession or big macro event that's impacting multifamily. But from a lender standpoint, multifamily is definitely up there as a coveted asset type.

So we're not seeing lenders necessarily turn away from it. They may be either overexposed to multifamily or they want to be a little bit more conservative when they're underwriting. Whether it's rent increases or valuations, especially for value add deals that were put into play 1218 months ago, any sort of massive rent growth or massive valuation increase is really being scrutinized much more heavily than it would have been. But other asset types, industrial with long term leases is definitely a popular asset retail. If it's long term tenants with long leases in a good market, low vacancy, there's definitely some appetite for that. Tim, I don't know, what are you noticing?

I look at the other aspect of this newspaper, Chris, about defaults with major real estate funds in New York City and I wonder and yes, there are headwinds for office. I mean, only 50% of physical occupancy is pre COVID for office means it's never recovered. And there's a problem with the office sector in some of these big markets. However, I look and I say, Chris, you and I both used to work in New York City years ago, right? And for me, a year and a half ago, I moved out, moved out of New Jersey New York City area and I moved down to Florida. And the millions of people that have made the exodus from big coastal cities and big northeast cities like New York that have moved to Florida like I have, or to Texas. I just wonder, is a lot of this activity somewhat isolated to New York? Right? And are people really not going to come back in a way that these cities need to power their economies and things like office space and even multifamily in a way that can avoid default? So I think it's going to be interesting for me to see, is New York the first default with some of these big defaults, or is this going to be isolated to certain markets and actually look at this as a location?

I think the truth must be somewhere in the middle. How much of it is New York versus how much of it is office? And multifamily as facing their own independent headwinds will remain to be seen, for sure.

And thinking a little bit about that, especially in New York, if you're 23, 24 year old, 24 years old, just out of school, it's very unlikely that you're leaving New York, Florida, right? You don't have a family, you don't have kids. You want to be in an office. You want to be in a city like New York where there's restaurants, there's activities, there's parks, there's nightlife. So, yeah, I agree. Tim It's somewhere in between, and it'll play out over time. But for certain parts of the population, sure, a move out of that market makes sense, but for other parts, that's where you want to be at that certain point in your life.

Yeah. All right, well, thank you. Those who have sent in questions, I think if you have some questions that you'd like to chat with the Stacksource team one on one rather than ask us on a live stream, please use that same email address that's on the screen. Hello@stacksource.com. We can put you in touch with a capital adviser contact if you do not have one. If you want to talk about deal structure, if you want to talk about capital markets, if you're a lender or capital provider that's not working with Stacksource yet and wants to be seeing deal flow and deal opportunities across the country, same email address, hello@stacksource.com. Or you can visit www.stacksource.com. So I have some more information. We plan to continue to come out with these monthly capital markets updates as long as our social media followers think this is helpful. So if you're on LinkedIn, YouTube, Facebook, please do leave a comment a like, get back to us. Let us know what you think. If you have questions or feedback for the next one, we love feedback. And so if there's something that you'd like to know about the capital markets that we may have data on, that we may have insight on, please give us a note.

So thank you, those of you that have joined us on one of the social media platforms. And I hope everybody has a great month.

Thanks, everybody.

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