We're seeing increased volatility and lower base rates in the capital markets. The economy will likely enter recession. But you can still get great financing for quality real estate deals. Here's how.
The commercial real estate industry has been nervous about an economic pullback for years at this point. After all, the consensus is that this industry is cyclical — that there are ups and downs that each come periodically and last for a while. It’s been quite a long upswing, so many investors have starting sitting on the sidelines waiting for a downturn.
What investors didn’t expect is an economic disruption from such a banal force as a virus. We were probably expecting more disruption from a novel new computer virus than this. But here we are. The whole world, it seems, is under the shadow of the novel coronavirus. A simple virus has altered the arc of the world’s economy.
So what does this mean for a real estate investor? For a real estate developer working on true construction deals? Are banks going to freeze up, making it impossible to refinance or fund new acquisitions?
Luckily, the short answer is No.
There are a lot of things happening in the market, but here are a few that are directly relevant to commercial real estate financing.
The federal reserve has dropped their own Fed Funds interest rate to effectively 0%. Prime is directly pegged to this index, so it has dropped too.
At the same time, we’ve already seen US Treasury yields drop quickly. Many loans from banks are set based on treasury yields, so this means lower interest rates in general.
Both stocks and bonds have been extremely volatile as investors deal with uncertainty. Commercial real estate can’t move as fast as stock or bonds, but they very much affect capital availability.
In order to bolster the economy, the Federal Reserve has restarted Quantitative Easing. This means they are buying bonds, which effectively pumps money out into the economy to increase liquidity.
As the market re-calibrates on how to price risk for different types of financial instruments, spreads are moving (upward). So a loan that was priced at 1% over Prime a few months ago might be priced at 1.25% over Prime by the same lender today.
Even with spreads adjusting, lenders do not want to be caught in an extremely low interest rate loan for years to come, particularly if the market rebounds and rates go back up. To protect their yield, lenders are increasingly utilizing interest rates floors.
We do not yet see a major portion of the population getting sick with coronavirus, but the containment protocols have workers staying home, potentially slowing down underwriting and processing of new loans, especially because refinancing volume is high. Third parties like inspectors, appraisers, etc may also have more limited access to properties. Plan for more time in closing.
It was never the ideal strategy to walk in to a local bank, ask for commercial real estate financing, and take the first offer that falls in your lap. But now more than ever, real estate investors need to “exercise the market” — explore multiple financing options from different lenders that are open to providing a quote on your asset.
In doing so, you’ll find that while rate indices have dropped across the board, the rest of the Capital Markets trends we call out above are happening unevenly across the market. Some banks are setting floors, while others are moving with the market each day. Many lenders are adjusting their spreads, but not all to the same degree. As a borrower, you have a lot of forces beyond your control affecting your investments — but don’t miss the opportunity to get great financing in place during this historically low interest rate period.
Speaking of tracking interest rates: we’ve just launched on new page on our website that will update both market indices and commercial mortgage rates daily.