January 2023 Capital Markets Recap

Tim Milazzo
February 14, 2023

CEO Tim Milazzo and Directors Chris Peters and 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.

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

All right, we are live with a commercial real estate capital markets update. I'm here with Chris Peters and Huber Bongolan, my StackSource colleagues. This is StackSource, live across LinkedIn, YouTube, and Facebook, and we have a commercial real estate capital markets update for January 2023. This is a capital markets update that we've been putting together as a team for the last couple of months. This is our first time going live on social media to talk through the updates to the capital markets, capital flows, and financial news across commercial real estate. And we're going to go ahead and dive in. And my colleague Chris Peters, Director of Inbound Originations for StackSource, is going to start with January capital markets and finance news that commercial real estate investors need to know.

Great. Thanks, Tim. Good afternoon everybody. I hope that you are having a great day, and a great week. As Tim mentioned, we're going to start with a recap of January. Obviously, there's been a lot of news floating around. What we do is we put together sort of the big pieces of news in the market, in real estate and rates and everything. So we'll kind of run through a couple of these. First, the Fed, obviously everybody's been watching the Fed bump rates over the past 12-13 months. The Federal Open Market Committee raised the Federal Reserve rate by 25 basis points, while the ten-year treasury yields actually declined 40 basis points in January. This has been the 8th increase in the Fed funds starting in late 2021 and early 2022. There's been a big divergence between short-term rates and long-term rates and rates that are more market controlled versus Fed control. So that's something that we've noticed and something we'll comment on shortly. Secondly, home prices. The Case Shiller index continues to decline. It's the fifth monthly decline starting in June of last year and dropping about 3.6% from June through November of last year. 

Lastly, apartment demand turns negative. Obviously, we've seen a lot of rent growth. We've seen a lot of demand from tenants, and a lot of demand from real estate investors. For the first time since 2009, the demand for new leases for apartments decreased as a result of a lack of consumer confidence and high inflation. Guys, any comments that you're seeing out there?

Yeah, Chris, I'll kick it off. So, Huber Bongolan, Director of Capital Markets. A pleasure to be here. Good afternoon. Good morning everyone, that's on the call. In regards to that first point, that market verse Fed, as most people know, on the call, the Federal Reserve has been increasing rates in an attempt to tame inflation, bring those inflation numbers down, and print prices back to a normal level of inflation. What we're finding interesting is the divergence between what the Federal Reserve is saying, that they're going to continue to increase rates, maybe at a slower pace, but still be data dependent. Looking at the data, where is inflation at? What are other indicators that they're looking at considering, but still they're going to be increasing just at a slower pace. While the market itself, investors, people like you on the call, they're thinking that by the second half of this year, Q3 or Q4, something may happen in the market or inflation data may be coming in better than expected, where the Fed will actually be lowering rates. So while the Fed hasn't said that the Fed has not made it public that they're going to start lowering rates, yet, the market is expecting that.

So what's also interesting to note on that first point is almost as equally as important as what the Fed actually does is what the market expects the Fed to do. So that's an interesting kind of tale of two cities there between the market expectations and what the Federal Reserve is actually doing with rates.

One thing that's notable to me in the January data that we've seen is apartment demand turning negative at the end of 2022 for the first time since 2009 in the wake of the global financial crisis. And for the last several years, while there's been speculation about when is the end of the real estate investment cycle, there's always been the caveat, well, at least industrial and multifamily have these long-term demand drivers, and those are going to be these stable asset classes no matter what happens with commercial real estate. Overall, this is the first time that we've had a really clear negative signal on the multifamily asset class. Now, there are still long-term demand drivers for multifamily. But whether this remains to be a trend that multifamily demand continues to be negative throughout a portion or all of 2023, or whether this was a blip on the radar at the end of 2022, as people and consumers really are nervous about the economy. It's going to be a really interesting thing to watch over the next coming months.

Yeah, and I would say there are a couple of points that I would add to that. The decrease in demand really is due to a decrease in consumer confidence. There's been no massive wave of move-outs, no jump in unpaid rent. Renters aren't doubling up. There's no flight to affordability. It's really just a decrease or lack of consumer confidence that's driving that demand. Moving on to the next slide, we're going to talk about some rates.

Excellent. Thank you, Chris. So on the slide here, ladies and gentlemen, you'll be able to see a couple of rates that we track, some metrics that we track. Inflation, the green, the gray, kind of goldish color that's the US 10-Y treasury dark blue, 2-Y treasury, and then the light blue is CME term SOFR, which is an index that's used a lot with bridge loans as the index plus the spread. What you'll notice here is, and very positively so, inflation is starting to, it looks like it's capping out. It looks like it's starting to trend down. Now, what we talked about in the previous slide, the Federal Reserve is going to want to make sure that trend continues. They don't want to and what they are calling in the market, Fed pivot, they don't want to turn and start letting the gas out of the brakes too early, and then that inflation starts to ramp back up. That's what they're scared might happen. So they're waiting for more data to be sure that that inflation trend that we're seeing going down, that that continues. Hopefully, rates below that, the US 10 Year treasury, and the two-year, term SOFR, hopefully start to top out.

As well, maybe following the same pattern, giving real estate investors a little bit of ease there, that rates won't continue their march strictly up and that we can start seeing some cooling in the market. When it comes to rates there, the last thing to note here that's kind of important is you may have heard this in the news, yield curve inversion. What that is, is that gold line and that dark blue line when the ten-year and the two-year cross, you'll see that that happens around July, August of last year where the two-year, the yields, the pricing on the two-year treasury, is actually more expensive than the ten-year treasury. In the typical yield curve, the ten-year should be priced higher than the two year, that inverted, that's typically a sign of maybe something recessionary, some type of contraction to come. But you'll notice that even today they are still inverted and we'll be watching closely for when those two lines normalize and ten year is then higher than the two year. We have a normal curve but currently, we are still inverted and we've been that way since around the middle of last year.

So let me pause there, and see if there's additional commentary for my teammates.

I would just add for those investors out there that are watching the equity stock market, seeing what's going on year to date, it's very promising. Yes, inflation is still high, but it's been coming down. Yes, rates have been increasing and will continue to increase but it seems like investors are optimistic about where the economy is heading and there might be a peak in rates or a terminal rate that occurs a lot sooner than expected. So for those of you that watch the equity markets, very promising news, especially today after Chairman Powell spoke.

This next chart here that you see is data that is kind of unique to StackSource. So StackSource, we track data on over 1000 unique capital providers across these different groups. You'll see here Freddie, Fannie, the agencies, CMBS, regional banks and credit unions, life companies, and debt funds. There are about eight different buckets of capital. We've highlighted the majority of them here. Each of them, we as a company were collecting data on, so that way we can help our clients and advise them better. Each provider row is unique. There are other terms to keep in mind. These are just interest rates. So there are other terms such as prepayment penalty, whether or not they require recourse, those are all going to be important. But as an equalizer, here are the range of rates that these capital providers typically operate in. StackSource, we're really the only website that tracks these commercial rates and updates them on a daily basis, giving you guys the power to know, hey, if I'm dealing with a specific type of provider, are they within this range that typically other players in their space operate between? So let me pause there, but this graph just kind of goes over all of the different rates.

The lower end of the spectrum, the higher end of the spectrum that these providers typically operate in, it's only the rates. There are other things and other nuances about these providers that you guys should also keep in mind that a teammate at StackSource can help you with. So let me pause there and see if there's any more commentary from Tim or Chris.

Sure. With commercial mortgage rates, it's been interesting to see that disagreement that you mentioned earlier with the Fed raising rates and treasury yields coming down. What that's done in effect is agency financing from Fannie Mae, Freddie Mac, and HUD, as well as regional and large bank loans. They've had lower rates since the beginning of the year since we saw that 40 basis point drop in January when debt funds and other private lenders for Bridge and Transitional capital, more closely correlate to that term SOFR and those short-term rates that are more largely influenced by the Fed, they've gotten more expensive. And so that's meant while banks and other stabilized capital providers may not be as aggressive, especially on construction and transitional assets, they have the best rates in the game right now and it's not close. The debt funds really can't compete on a rate basis right now. And that's an interesting trend to watch.

And something I forgot to mention about the rates is you'll see here, the whole rate. But typically, and most investors know this, sometimes these lenders are fixed depending on the lender, right? And sometimes they're floating. So the rates that you see here represent the all-in kind of when you take if they are a fixed lender and they're quoting just one fixed rate, or if they're taking an index such as one of the Treasuries or term SOFR plus that spread this would be the whole rate there.

Yeah. Huber, the only thing I would add here is you mentioned bank rates. Look at the spread. It's over 400 basis points from the low end to the high end. We really are seeing a wide range of rates from banks and credit unions. So for those of you investors out there that have a deal in hand or you're putting numbers in and doing some underwriting, number one, I would be conservative in your underwriting. And number two, I would try to talk to as many lenders as possible because it really does range from that range is accurate and it's true. We're seeing it when we're talking to lenders. So it's definitely best to get your deal in front of a lot of lenders.

Absolutely. And one of those nuances that we talked about is unlike CMBS, where maybe they want to look at only stabilized cash-flowing deals, banks and credit unions, some of them have the capability of looking at value add deals, and construction deals, especially regional ones where they want to lend in their markets. So the reason for that 400 basis spread that you said really is because banks and credit unions have a lot of products that can capture different types of deals, whether that be a perm deal, value add deal, construction deal, they have quite the spread there. Great, excellent. So with that, I will pass it back to Chris for some insights on underwriting and deal structuring and how these have been changing over the past 30 to 45 days. Chris.

All right, perfect. Thanks, Huber. Yeah, we've noticed a lot of changes, and different parts of commercial real estate finance have changed at different points in time. Leverage was a big issue that changed coming out of COVID. Some of the recent changes are that we're seeing regional banks and community banks grabbing a larger market share in commercial real estate loans versus the large lenders like Bank of America, Wells Fargo, and JPMorgan, a lot of these regional community banks can get pretty creative and have flexible structures. The cost of capital can be vastly different than a large bank. Oftentimes they are a lot more flexible in their underwriting, not meaning they're not going to underwrite the deal, but they may be less checkbox driven and more flexible with understanding what really is an investor looking for and being able to work with them. So, yeah, we've definitely seen the smaller regional community banks picking up some of the market share from the larger banks. For those of you that like non-recourse, multifamily financing, agency rates have come down, they were definitely not as competitive versus banks and credit unions. We've seen them come down recently, potentially offering some interest only, which is very attractive.

Agency, as a reminder, is non-recourse financing, long-term, perm debt, 30-year amortizations, and the potential for some interest only. So the fact that they're getting a little bit more aggressive in trying to win deals is a good sign for the market. Lastly, bridge loans, these are for the most part, are debt funds or private lenders. They're really stressing the exit. Right? We don't know where rates are going to be. We don't want to bet on rates being significantly lower. And then you get into a pickle where you can't get a takeout loan. And that bridge lender is now either stuck with a loan or stuck with the property. So these bridge lenders, are they're really stress testing that exit to make sure that they can get taken out. Huber, any additional commentary?

Yeah, let me jump in with some color on that last one. So it's very interesting in, let's say, the last two to five years or so, when the market was very hot, a lot of liquidity in the market, a lot of credit out, bridge lenders were more so LTC focused. They look at the total cost, break it down, and make sure they were comfortable with the cost, the land, whether it be land at cost or land at value. Right? And they would structure an interest reserve so that way they get paid back when that take-out event happens. We didn't really hear too much now, some we did, some we did. There are a lot of bridge lenders out there with a lot of options. But you didn't hear too much about bridge lenders really stressing and being worried about whether it be financing 6 months, 12 months, or 18 months from now when that bridge comes due. So that's something that we are seeing as a team here at StackSource. We're seeing bridge lenders start to ask the question more, hey, if I size this at 80% LTC loan to cost, let me take a look at that DSCR because I know a bank lender, CMBS, they're going to be looking at these metrics debt yield or DSCR.

And I want to make sure that the total loan amount that I'm giving there will be at home. So just for everyone on the call here, putting some meat on the bones, one that we saw that came in was a bridge lender that historically did not really ask about DSCR. Now showing us, hey, will this cover at a 6.25 interest rate with a 30-year amortization 1.2, 1.25 DSCR? Will I be able to get a takeout for this? So, very interesting to see that, yes, people are still lending, but they're being more thoughtful on their underwriting.

Awesome. All right, we'll turn it back over to Tim to do a look ahead at the next months ahead.

Excellent. Well, thank you, Chris and Huber, for covering what we've been seeing over the last few months as we look ahead, the treasury yields curve inversion, which Huber mentioned and explained on that line graph that's been inverted for 6 months now. This is a classic recession signal. Something that you learn about in a bachelor-level economics class or in your first finance job is to watch out for yield curve inversion. So not only have we had two-year to ten-year treasury yield curve inversion, but only just in the last 45 days have we seen the crossing of the overnight lending rates as measured by SOFR across that treasury line as well. So we have a full yield curve inversion and that is always a signal to look ahead at potential recession. The second thing is, over this twelve-month period in 2023, it is the largest refinancing volume as measured in the securitized markets, and what we can measure from public records about loans coming due, it's the largest refinancing wave of any year this decade. And so lenders and investors alike are watching for increases in delinquency rates, watching for “where will interest rates be as my loan comes due in 30 days or in 120 days?”

What are interest rates? And as Huber mentioned, for bridge lenders, some of these can be CBO bridge loans that originated a year or two ago, some of them are ten-year CMBS loans that originated in 2013. You have to look at that property's cash flow and does it support a new loan to be refinanced? Or are these sponsors, are they going to be forced to sell those assets or refinance with multiple tranches of capital? Will we have some, especially coming off of bridge loans and CDOs? Are we going to have some cash in refinancing activity? This is an interesting trend to watch for the months ahead as well, depending on where rates end up settling in the next few months. So we'll get over to a Q and A in a minute. And if you are watching live, you can certainly enter a comment if you have a question. But before I turn over to Chris, just a little bit about StackSource for about 40 seconds. We are expert capital advisors. There's a team of capital advisors that work for StackSource across the country. We arrange debt and equity for commercial real estate deals.

We have a nationwide reach. We have arranged over $1.5 billion in capital across 45 states. We help investors find competitive terms for financing, and we do that with transparency. So that means transparency to our process and our pricing, and what capital sources are you matched with via our online portal. So that's a little bit about StackSource. You can learn a little bit about us or connect with a capital advisor on Stacksource.com. But I will pass it back over to Chris to manage the Q and A.

All right, great. Thanks, Tim. Yes. So for those of you that are live, we've had a couple of questions come in already, but feel free to send those in if you come up with questions at a later point in time. You can always reach out to anybody here at StackSource or reach out to hello@stacksource.com. So, first question, and Tim, you had mentioned cash-in. Are lenders allowing cash out? And if so, what sort of terms and structure are lenders looking for these days?

Chris, I'd love your opinion on this too, but in my case, a couple of things related to cash-out refinances that I think are noteworthy. One is that some sponsors are trying to avoid a traditional cash-out refinance, which was a huge trend over the last few years, where cash-out refinance was the name of the game, and some are actually trying to keep a preexisting loan, especially if it's at a 3% or 3.5% interest rate, and take subordinate capital underneath as a way to cash out on their properties. Now, in commercial real estate, unlike a home that you have equity built up, there's typically not a nice flexible home equity line of credit structure. But there are several ways to take cash out on top of a preexisting loan or a seller finance or a seller assumed loan. And so mezzanine debt and other forms of secondary cash out are certainly possible and are increasing in prevalence. So I think that's one thing that is noteworthy. But Chris, and Huber, I’d love your thoughts on just cash out and how commercial mortgage lenders are looking when somebody is doing a true refinance.

Absolutely. Yeah, as if the equity is there, a lot of it rests on the appraisal. So if the appraiser that goes out and the appraisal report justifies cash out based on the stipulations that are in your term sheet, lenders are still willing to give it. Now, what puts you in a better position is when you say or when you plan on your cash out to be reinvested in the property through some type of CAPEX, whether it be interior maintenance or deferred exterior maintenance. If you are using the cash out to improve the collateral in the property, lenders love that because you can imagine, remember, they're taking a first trustee mortgage, most of them on the property itself, on the collateral. So if you're taking cash out to even improve that property, that's a much better sell when the person on the other end, the lender, has to go to their credit committee to explain what you want the cash out for. So cash-out providers, they're absolutely still out there, really depends on the appraisal and the current credit steps of that specific lender. And to put yourself in the best position for max proceeds, having a story and having justified line items of where you're going to invest that capital back into the property puts you in a really good position.

Yeah, guys, I agree. As long as you're hitting a minimum DSCR and maybe it's higher on a cash-out, maybe it's one three or one three five or one four versus maybe a one two five. If you're acquiring the property, as long as your cash flows there, tenants are paying, as Huber mentioned, it'd be great if you're pumping that money back into the property. But yes, I fully agree that lenders are certainly open to cash out. It's a little bit different than it was two or three years ago when most lenders were not allowing cash out, but yes, it's become a lot more flexible. Another question came in, given where rates are and where they might be in the next six to twelve months if I'm acquiring a property, how can I protect myself against potential rising rates, but then falling rates in the future?

Sure, I'll jump in and kick this one off. So there are actually third-party providers, many people on this call, forced to purchase one. They're called rate caps. So there are specific providers that are really good at doing this. Think of it as an insurance policy against what Chris just said. If rates continue to rise and you're in some type of floating rate situation with your lender, then you can purchase what's called an interest rate cap, which is an insurance policy. And just like an insurance policy where you can determine, hey, how much of a deductible do I want, how much coverage do I want? It almost works very similarly in the real estate interest rate world. Like, where do you want that cap to be, where do you want it to where the ceiling is, and you don't want to pay any more above that. What's the duration? Is this a cap that you want good for twelve months, a cap good for 18 months, or two years? Right. All of that goes into determining what the premium you're going to be paying for it.

But there are absolutely insurance policies that you can buy in order to protect you as an investor against interest rates rising in a floating rate type situation.

Yeah, the only other thing I would add is thinking about ways to get creative with a loan structure. If I'm a believer that rates are going to be lower in 18 months or 24 months, maybe I want to get into a shorter-term loan that I have the ability to get out of or prepay out of or refinance out of in two to three years. Right. So maybe focusing on the back end of that loan and having the flexibility to get out to get into something at a lower rate in 18 to 24 months. So, yeah, there are multiple ways you can think about it.

Yeah, that's true. We're hearing that a lot from our clients is that exact theme of making sure the lender has no flexible prepay. So, again, one of the things that we track here at StackSource is lenders' capabilities, what are their nuances, and what are the prepays? The penalty is absolutely one of them. And you can find out that there are different lenders that won't require a prepay. So that way if the situation comes, like Chris just said, and rates are lower, you can refinance without a penalty.

Okay, we have one other question coming in. Since we are in a coverage-constrained environment. What are you seeing from an interest rate on the exit on acquisitions? Is it a spread over the going-in cap rate or an assumption of, say, 6 to 6.5% Huber? Maybe this was similar to stress type thing.

I can reiterate that and then please, Tim or Chris, jump in. So in case it was missed earlier, some lenders are starting to, especially bridge lenders, they're starting to stress the takeout. Somewhere in the mid-sixes, I've heard mid-sixes to low sevens, depending on the type of lender stressing their exit. Now, the reason for that is when is your exit right? If you're in a bridge-type situation and your exit is 12 to 18 months from now, or are you currently seeking a perm option and that exit is going to be 5 years, 10 years from now, where the future is even less certain, I would say the shorter duration you can expect interest rates probably somewhere like an exit  Interest rate DSCR coverage test somewhere in the low to mid sixes and the farther you go out, low to mid sevens, somewhere in that range. What's beautiful is if your deal works now, right, and the market, and if expectations happen to where interest rates do lower in the future, then you put yourself in a really good position for a cash-out refinance like we just talked about.

Yeah. I would add we haven't really mentioned it much on this call, but debt yield is another requirement that lenders think about and investors should have in the back of their head. Multifamily. Two, three years ago, we were looking at debt yields of seven, seven and a quarter, seven and a half. Today we're looking at debt yields in the high single digits, ten, maybe higher. So underwriting to a debt yield of 9-10.5% t is probably something in my mind where I have some cushion there.

I'll say, on debt yields, and you're not wrong, Chris. But the whole point of debt yield becoming more useful, especially since the global financial crisis, I think when debt yields became a little bit more popular versus DSCR with some lenders in reaction to the super low-interest rate environment where everything had a healthy DSCR. The idea behind debt yields was that the standards wouldn't change over time as interest rates go up and down, though, I guess that's not fully fair because really they should be a certain spread over a cap rate and a market cap rate, rather than influenced by the wins of interest rates. So I might be getting a little bit philosophical on us. Debt yields really should be more time tested, like, hey, if multifamily makes sense at seven and a half year debt yield, it makes sense at seven-and-a-half debt yields, though I think that should shift logically more over time as cap rates go up rather than interest rates going up. But if you have a lender that tells you, hey, our debt yield requirement is higher than it was a few months ago, that's probably an indication that either, one, they were really a DSCR lender anyway, or two, they think cap rates are headed up and that means property values are headed down.

And that is its own signal to me.

Good point.

Yeah, I think one last closing thought on my end is a lot of the information that the viewers just got very macro higher. What we're seeing on a big basis right, there's going to be exceptions to the rule. These are just rules of thumb of what we're seeing. You're probably asking and wondering to yourself, what about my situation macro? Like for me, my area rents aren't going down. For me, my area, I'm seeing lenders get more aggressive and that's excellent. Please do reach out to us. You see a website there as well as our email there because we probably have a teammate in your area, StackSource teammate, that knows your market, that knows how regional lenders are operating specific to you. So while a lot of the information you just got today is very macro, what we're seeing in the big environment for you, specifically micro, please do reach out because we can forward you. Like, I'm in Los Angeles, Chris is in Chicago, Tim is in Florida. We have about 20-30 other team members across the nation that can help you for your specific regional deal.

What an excellent point to end on Huber. So thank you for that. And guys, up on the screen, for the viewers, whether you're watching this live or in the future, hello@stacksource.com is a great way to quickly get assigned a Stack Source representative if you don't already have one. If you already have a capital adviser that you're working with, by all means ask them about your specific deals, ask them about the market, or ask your Stacksource rep for a copy of this presentation if you'd like one, and they'll send you a link to download. But if you have more questions about the capital markets, please do reach out or join us again on LinkedIn Live this time next month and we will talk about what we've seen in February. So Huber, Chris, thanks so much for joining the live stream with me here. Thank you, StackSource marketing team for helping put this together, and for the investors and lenders that we're working with, we hope we can continue working with you and finding some great solutions in the capital markets. So thank you everyone and hope you have a great night.

Thanks, everybody.

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