July 2023 Capital Markets Recap

Tim Milazzo
August 1, 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: 

All right, welcome back. Welcome to our July recap of our commercial real estate capital markets. My name is Huber Bongolan and I serve as StackSources Director of Capital Markets. And I'm joined today by my colleague, Chris Peters, our director of Inbound Originations. With the Fed meeting in July, we have a lot to talk about, so let's get right into it. Thank you, guys, so much for joining us. And with that, I'll pass it over to my colleague, Chris.

Awesome. Thanks, Huber. Hope everybody's having a great summer so far. We had a couple of noteworthy news items. On July 1, the Fed raised interest rates by 25 basis points after briefly pausing rate hikes. Last month, the Fed Reserve raised its benchmarked interest rate to the highest level in 22 years. The quarter-point increase brings the Fed funds rate to a target range of five and a quarter to five and a half percent, the highest point since 2001. Inflation. Obviously, we've been talking a lot about inflation. Inflation fell to a two-year low to an annual rate of 3% in June, dropping to nearly a third from the level it was about a year ago. Looking at some of the components, gas was a notable component of the fall. Gas declined 27% on an annual basis, which was very noteworthy and viewed favorably by consumers. Airfare also fell in June and contributed to the decrease. Lastly, the economy continues to grow and prove resilient to the higher interest rate environment. The Bureau of Economic Analysis reported that the economy grew at an annualized pace of 2.4% through Q2, which was higher than the expected 1.8% and outpaced Q1's reading of 2%.

Consumer spending remains strong and is showing resiliency in the face of higher interest rates and inflation. And GDP hasn't posted negative readings since Q Two of 2022. So some bright spots in the economy there. Huber.

Excellent. Great to hear. And our next slide, we'll put some context here in terms of a graphical representation of some of the things that Chris was speaking about. One of the welcome signs that you'll see here is in green so we're tracking all of the rate changes, specific rates that we're tracking here in green. Inflation is kind of the goldish-yellowish color that's our ten-year treasury. Dark blue is our two-year treasury, and then light blue is our term SOFR. So one of the welcome signs that Chris was speaking about was inflation coming down. You'll see that it peaked kind of middle of this year and since then has been trending downwards. Chris had mentioned we're currently at 3% inflation, and as most of us know on the call, one of the Federal Reserve's mandates is to get that down to 2%. So while we've come a long way, there are still a couple more things to be done in order to get to that 2%. So as rates you see there, the kind of the lower ones, the gold the ten years, the two years, and the term SOFR. You see that rates are still increasing, but a welcome sign is that they're increasing at a slower rate than they did in the first half of the year.

The middle two rates that we always find interesting, are the two-year treasury and the ten-year treasury. You'll notice that that curve, we call that yield curve inversion, that curve that spread between the two-year and the ten-year, it's inverted because the yield on a two-year treasury is still higher than a ten-year treasury. So we're watching for that. That occurred kind of middle of last year as well. So we're watching and tracking that for a curve normalization where the yield on a ten-year is lower excuse me, is higher than a two-year. So currently still inverted. And one of the key metrics that we're tracking on the next slide you'll see here, is current commercial mortgage rates as of today. So all of these rates, I know they're quick, some of you maybe can snippet or take a picture, but you can also find it on our website. So there's a link at the bottom where if you were curious hey, depending on what type of lender I send my deal to, what would be the typical range of rates I can expect from that type of lender? So this chart here, only shows the rate.

Of course, there are many other variables when it comes to picking the right capital markets provider for you. We have a team here at StackSource. Chris will go into it later, but we have a team that can help give advice. Rate is just one of the variables. As many of you know, there's the term, there's prepay penalty, there's recourse and different ways of structuring it. But if you're curious about just isolating one of those in a vacuum, looking at rates here, the different types of ranges of rates that we're tracking for each type of capital rider here and again, you can go to our website to see them in real-time now. I'll pass it back over to Chris to review some underwriting and deal structuring topics of the month.

Thanks, Huber. Yeah, it's been a wild month. Obviously a wild summer. Rates are continuing to impact how lenders view commercial real estate transactions, acquisitions, and refinances. It's also impacting how investors structure their deals. We've touched a lot on the first bullet point turmoil in the banking industry, right? We've seen a couple of banks go under, a couple of banks being sold and regulators are really coming in and hammering these banks. So the focus is on deposits, right? These banks take their deposits and they leverage them to lend out to borrowers in the form of commercial real estate loans, CNI loans, equipment loans, and stuff like that. So when we're bringing deals out to the market and we're talking to banks and credit unions, conventional type lenders, their focus is on securing deposits, right? So gone are the days, at least for the time being, where you can take a deal out to any bank in the market and sort of get quotes from all of them, right? Some of them are either not lending or only focusing on existing relationships. Some will say sure we'll look at this deal but we want X percentage of the loan in deposits or X dollars in deposits.

This is a function of that institution potentially losing deposits to a larger institution or needing to meet certain financial or liquidity ratios internally when they're making new loans. So definitely still focus on lenders securing deposits to form new relationships. Something else we're noticing, and it might be a little bit regional, but for those of you on the Coast, East Coast, West Coast, or in the south, the cost of insurance has been increasing. We're noticing it on folks that are either building new properties or acquiring new properties and they're going to their local insurance agent or insurance broker and they're pricing out insurance or on renewals, the cost of insurance is going up. And that's really impacting how an investor underwrites a deal and how a lender underwrites a deal it's an increased expense and therefore decreasing NOI. And with a lower NOI that really impacts the debt service coverage ratio. So a higher expense will ultimately lead to potentially a lower loan amount. We know farmers, I think it is, are completely exiting the Florida market because the cost of insurance just doesn't make sense. So definitely something that we're noticing in our conversations with borrowers and when speaking with lenders, some of the typical questions are do they have a new insurance policy coming due?

Have they priced out insurance? Is their insurance in pro forma reflecting the current rates or those old rates that need to be updated? So the cost of insurance is definitely impacting how investors and lenders are underwriting a deal.

Great. So on this slide, we'll be discussing some of the things and bullet points we're looking forward to in the months ahead. I don't know about everyone else on this call but whenever Jerome Powell, the Federal Reserve, when he speaks, we all listen. Last Wednesday, glued to the screen. So no secret as he's been saying, the Fed will be data dependent. They will await the data. There are certain reports on inflation coming out between now and their next meeting as well as employment. So based on the data that they see in those reports, they will make future either increases or pauses. Based on that. There wasn't any signaling of a rate cut. I know the beginning of this year that was on a lot of people's minds that by the end of this year, there was a good chance that there would be a rate cut. But that doesn't seem to be the tone. He has not said that previously and he's continuing to stick by. If at best it would be a pause if at worst, it would be another increase. But that will depend on what data comes out. So that's something that we'll be eagerly awaiting in the months ahead.

Second bullet point. There are office loan modifications. It's been dominating the headlines. Right now, office space, the traditional office space is in trouble. Now, not all office is the same, right? You have a traditional office, you have a medical office, different types of special purpose. But for traditional office spaces that may not be in the best area, may not be of the highest quality, loan modification, and default continuing, those will probably continue to dominate the headlines and we're looking to see for solutions to those in the months ahead. Third bullet point. I'm sure many are feeling it right now, but trouble in refinance land. Of course, due to rates being high, you have a harder time with your refinances. Chris had talked about banks wanting deposits, and how increasing the insurance costs is causing harder to underwrite. Well, of course, with higher interest rates, it also makes it harder to get the amount of loan proceeds that some that are looking to refinance need in order to refinance their old loan. So one of the terms that we're starting to hear more and more now is cash in. So I think most on this call might be familiar with the term cash out.

Right? That's typical. You add value, you're looking to refinance, take cash out. But in this unique time, a term that we're starting to hear now that previously we didn't hear too often is cash in. And what that basically means is because loan proceeds are being depressed at the moment and you may have a loan amount that you're looking to refinance, lenders are asking our sponsors to come to the difference between that spread between that and putting cash into the deal in order to get your next loan. Refinancing gives you more time and more of a term. So in these moments, maybe a no pre-penalty is something you might be looking for to structure into your deal. But we are seeing that, and we'll continue to look at that in the months ahead, these cash-in type situations. And lastly, bullet point number four. There are private lenders being flush with cash. That being a potential solution to where, hey, if you had deferred maintenance, if you had something you want to do to the property, if there was some type of bridge transitional play that you had, now might be a good time. Because private lenders are flush with cash.

They're usually one to three-year terms, short terms. You're only paying interest only on that cash. You're adding value in the meantime. So that could be a potential solution. So we're looking forward in the months ahead to see how private lenders step up with that availability of cash on their books. So those are some of the things we're looking forward to in the months ahead that we'll be tracking. And with that, I'll pass it back over to Chris.

Thanks, Huber. Yeah, we're going to be busy through the end of the summer and early into fall. So excited to see what happens. Just a reminder stack Source we are a commercial real estate financing platform. We have about 1000 capital sources on our platform, ranging from banks, credit unions, life co-agency debt funds, CMBS, private lenders, REITs, Family Offices, and private equity. We've done about a billion and a half of financing across 46 states. We pride ourselves on being transparent and efficient and quick. So any financing requests or any capital markets inquiries, by all means, please reach out. Happy to discuss this at this point. We will take some Q and A. You can ask questions directly in the comment section or you can email us at hello@stacksource.com. We have a couple of questions coming in. Let me pull them up real quick. Okay, the first question is actually about our last bullet point about how can private lenders being flush with cash impact the lending landscape and whether are there any potential opportunities for borrowers. Huber, do you want to take a stab at that one?

Yeah. So, as I discussed with private lenders, being so flush with cash right now is a great time where if you had some type of deferred maintenance or deferred value-add strategy while most of our clients are waiting for rates to normalize if you're in a position where you needed to refinance, this could be a potential option for you. These rates are still in the high single to low double digits in that range, depending of course, on how much of a lift, what's the situation. But now would be a great time because not only are payments only interest only, so that helps with the cash flow. These are usually shorter-term deals, one to three-year deals. They don't have a prepay penalty. So once rates normalize, if that was what your game plan was, this could be a solution for you looking at potential bridge deals through private lending relationships.

Yeah, I agree. Huber. I think the only thing I would add is we're seeing investors now focus on their property, getting it in shape to refinance when rates do come down. We're hearing investors focus less on getting the absolute best rate or the absolute best terms. And they're just focusing on getting their financing in place. That allows them to stabilize a property or increase rents or decrease expenses, but really get the property into shape so that when rates come back down in a year or two, they can lock in long-term financing. So that's something I'm noticing. And private lenders are definitely much easier to work with. They have typically a much smoother underwriting process. There are fewer bells and whistles, so it's just an overall better experience. It's just a slightly higher rate and fees. All right, let's see another question coming in. Why are lenders now requiring and this goes into the cash-in? Why are lenders now requiring borrowers to bring cash in for refinancing? And how is this affecting the market? I can take a stab at this one and then Huber. I know you touched on it earlier, but yeah, cash out is certainly still a possibility.

The higher interest rate is increasing the cost of debt and ultimately it's increasing annual debt service therefore you need a higher NOI to meet certain DSCR requirements. So for those properties that are in good shape and that have sufficient cash flow and are not overly levered, we're definitely seeing lenders still provide cash out for properties that either went through a transition over the past year. And were financed with cheap debt a year or two ago. And now they're going for a cash-out refinance or even a refinance in general. That may not be the case. The higher interest rates were not during their underwriting, they probably were not accounting for higher interest rates. They probably were not accounting for a slowdown or a reduction in rental income. So it's sort of a two-pronged approach that a lot of these investors were not prepared for. Now that the property transition is over, or they're just looking to get out of a higher price debt, we're definitely seeing investors require cash in to meet certain DSCR requirements. This is exactly where I know I've touched on it a lot in the past, but structured finance comes in, whether it's mezzanine financing, preferred equity, or other sorts of equity, investors have to get creative if their senior loan doesn't size to the right dollar amount, coming up with other sorts of capital is definitely a possibility.

Yeah, exactly. And you had mentioned a key concept there in terms of cash-out requests, and I'd say for anyone on the call, strategically lenders want to see that cash out is going back into the property right? While it's still possible to get cash out. If the appraisal helps with the credit committee's decision on how much cash out to right. If they can see that money that they're giving is going to even improve the property more.

For sure. Yeah.

Nice. And then I see here, there's a comment here from Lester Siddad Real and the answer from Philip. So the question was, what are the DSCR, are lenders expecting? And there'll be an answer at 1.25. So really depends on the type of lender. And again, business plan as well, property type, the range that you're seeing, you can still see some lenders at 1.15 or even 1.10 in order to help with that sizing issue. You're more likely to see lenders in the 1.25 to 1.35 space. That's more typical. But of course, every business plan is different, but you're typically seeing it in that range. I would say 1.25 to 1.35. Are you seeing the same there, Chris?

Yeah, and it might be market or asset specific too. They might be at one, two, or one two five for multifamily, but for office, they might be at one-four. Right. And on acquisition, they might be at one-two or one-two-five. But on the same asset, they might be one three or one three five on a refinance. Right. So there are a lot of factors. There's nothing set in stone where you have to be at one two five. That's sort of the advantage of going out to multiple lenders because you'll have different lenders that underwrite differently and have different credit criteria. So it really does depend on a lot of different factors, but good question. I think we have time for a couple more. Going back to the Federal Reserve, what are the indicators that the Federal Reserve is watching for before considering a rate OOH rate cut?

I'm sure, again, the beginning of the year that was on everyone's mind is when are they going to cut rates and the pace at which they were increasing. But it's inflation and unemployment rate. Right. As you see inflation continues to trend down, which warrants a pause. Right. And then if they're going to try to speed up the economy be because maybe and he had mentioned this, Mr. Powell on the call, like, how much is too much versus not acting soon enough, right? And the data that we're looking at is kind of older data. So it'll be inflation and unemployment. Those are the main two indicators. And depending on if they need to speed up the market, if they need to jumpstart things, then that is a tool that they have and that is the tool. It's lowering interest rates, but that is soon to be said. So time will tell, and we're looking forward to those reports coming out in the next two months.

Yeah, I agree. I mean, the strong GDP print jobs numbers are hanging in there. Inflation is coming down. So it almost seems like the Fed is not really being incentivized to cut rates at the moment. And that's why you're seeing a lot of people kick out their rate cuts, know, early middle of next year at the Huber. I agree. I mean, they really are trying to slow down the economy, and they're doing a good job of bringing inflation down while the economy is still humming. So we're in a pretty good spot overall. All right, last question here. Let's see here. So this sort of goes back to some of the banks and credit unions. In what ways are banks and credit unions adapting their underwriting and deal structures to focus on relationships and deposits?

Great one. I'll kick it off, Chris, and then pass it back to you on what you're seeing, too. So things that we're seeing is a quote, some of the top quotes that we're hearing. This isn't all lenders, so don't hear this and say, oh, my gosh, all lenders are acting this way. These is just some of the ones that we've been hearing nowadays that we didn't really hear previously in the past. So one is on pause for new relationships they want to service or only are looking to service their existing clientele. So on pause or looking to service their only existing clientele. And the most interesting one that we've heard recently is requiring as part of the term sheet, requiring that the sponsor set up a depository relationship of 25% of the loan amount. Right. So that was interesting to hear just upfront off the bat before looking at the deal that they would require that 25% injection into their balance sheet. Chris, what are you hearing? Anything else?

Yeah, no, I think that's spot on. Yeah, I've seen some deals where in-place cash flow isn't there. The pro forma looks great, but in place, cash flow might be a little light. I think historically a lender might pass on the deal, but if they can get some deposits and make it worth going through the exercise of underwriting the deal and maybe some of those deposits are released over time as the property hits certain Occupancy levels or certain DSCR levels, then some of the deposits will be released. So, yeah, deposits are important and I've definitely seen them be used as a tool to get a deal done where it may not get done without the deposits.


Yeah, definitely going to be a focus for lenders for sure.

Excellent, Chris. Perfect segue on that one. So we had one more question come in, but Alex, let's meet after this. So Huber at Stacksource. Chris@stacksource.com, for everyone on the call. Stacksource.com, that's where you can go to find us under team. You can see our website if you'd like to reach out to us individually, our contacts are there. So thank you everyone for tuning in with us this month and we look forward to speaking again and sharing our insights at our next meeting meeting a month from now. So thank you, everyone, for joining us. Have a great rest of your week. Thank you, Chris. Thank you, everyone.

Thanks, Huber. Thanks, everybody. Bye.

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