June 2023 Capital Markets Recap

Tim Milazzo
July 7, 2023

CEO Tim Milazzo and Director of Inbound Originations 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.

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

Happy July 4 week. We are doing a capital markets update for the commercial real estate market reviewing June 2023. We're StackSource. I'm Tim Milazzo, co-founder and CEO, and I'm here with my colleague and director in our Chicago office, Chris Peters. How are you doing Chris?

I'm doing well, Tim. Happy Fourth. How are you doing?

I'm doing great. Well, we've had an exciting month as far as capital markets news and updates and so we're going to go through some news and implications for commercial real estate investors. So Chris, what are the biggest stories to know from June for commercial real estate capital markets?

Yeah, I'd say that one of the biggest pieces of news that came out in June was the Fed pause on rate hikes. It had been raising rates for ten consecutive sessions starting in March of 2022. Increasing rates by about 5%, increasing short-term rates 5%. So the Fed pausing is really sort of allowing investors to take a step back, figure out, okay, where are rates going? Are they going to continue to go up? Are they going to hang out here for a little bit or come down? So the Fed pause, we'll talk more about it a little bit, but that was definitely a key piece of news that happened in June. Secondly, there was a bank stress test. This was born out of the great financial crisis. All 23 of the US banks included in the stress test weathered a severe recession scenario while continuing to lend to consumers and corporations. This is big. We have data on what a great severe recession or downturn looks like. So the fact that these 23 banks passed is a great sign for the economy and for lending in general. Lastly, Lifeco originations are down 60% year over year according to SP.

This is big because Lifeco tends to focus on mid-size and large transactions. They tend to be much more conservative than private lenders or debt funds. They're going to be much lower LTV, but they're really providing long-term, fixed-rate, potentially non-recourse financing. So we've seen property valuations come down, we've seen debt service increase, we've seen cash flow decrease. Rents may not be increasing as much as expected. So Lifeco being the naturally more conservative lender that they are, obviously we're in a tricky environment, so their originations have come down pretty significantly.

Yeah, and I think my note on that is that it's broadly in line with where the commercial mortgage market overall has been in the first half of the year. So I think the Mortgage Bankers Alliance has estimated that commercial mortgage origination overall was down 56% year over year in Q1. So we're seeing 60% for Lifeco. So they're not bucking the trend. It's another major group of lenders that's not bucking that trend. And while they have as we shift to looking at rates, lifecos have some of the most favorable rates in the market. They are playing into the classic lifeco strategy of being very conservative now as we look at the rate trends for a few different indices in the market. So our top dark green line here is inflation that spiked several months ago and in late 2022 we've seen inflation kind of level out and it's still coming down but it's not near that 2% long-term Federal Reserve target yet. And so we have the Federal Reserve not as you noted Chris, raising short-term rates last meeting, but they still have wood to chop as far as fighting inflation to get it down to that 2% long-term target.

So there is speculation in the market that could continue to go up further as far as the Fed funds rate and therefore the prime rate and short-term rates overall. The other notable thing is we look at Treasuries so we have a two-year treasury and a ten-year treasury line. We are now at more than 250 days of yield curve inversion between the two and the tenure. It is the longest yield curve inversion since 1980 when we saw 400 days of inversion and that led to some of the highest rates and the highest interest rates on record for the US economy. So that's something to keep an eye on as far as rate trends. Inflation coming down looks good, but yield curve inversion is troubling. So what will happen in the coming months from that? And we'll talk a little bit about the coming months in a few moments as we shift to the commercial mortgage rate table we are seeing more discrepancies between similar types of lenders. Regional bank versus regional bank, credit union versus credit union quoting deals at a wide range of rates. And so there is a wide range of rates when we look at regional banks and credit unions on this chart and that's part of the reason for that is some of the regional banks and credit unions may quote a deal over prime and prime now being at eight and a quarter.

That's going to be very different than a regional bank quoting a deal at ten-year treasury plus and that could be in the sixes. There's a wide range in some of these. The CMBS market is alive but Limping lifecos are being conservative. As we mentioned, the agencies are just about the only large pool of capital that we're seeing move in a way that would have been expected so far this year and that's because it's government agency backed. There is available capital for all types of deals, though many deals. It's going to depend on the debt service coverage ratio to see where you are in this range of rates, generally speaking, to see if you're at the lower range or the higher. This is always available on the Stacksource website by clicking rates on the top or going straight to Stacksource.com/commercialmortgagerates, we have it updated daily if you're in need of checking out where commercial mortgage rates are now. Okay, so let's talk about deal structure. Chris, what are we seeing as far as shifts in what lenders are quoting and what capital providers are able to do in today's market?

Yeah, it's a tricky environment. For those of you that are bringing deals out or have been talking to your lenders about financing a new acquisition, financing a new development, refinancing a property, or pulling cash out. It's definitely a pretty tricky environment. We're going to highlight a couple of aspects here, but there are certainly other things that we're noticing in the market. First off, in traditional office, the capital markets are really thinning out, we've noticed, and this has been going on for a while with the work from Home Trend. offices, I think, are becoming a little bit more populated. Right. But on certain days of the week, and overall, lenders are pretty skittish on how that's going to play out. If this work from Home Trend is really here to stay, what does that mean for larger tenants that occupy a significant amount of space within an office? Do they leave? Do they downsize? There's still a lot of unknown here. And so when you're bringing an office deal out to the market to secure financing yeah, there's a lot of lenders that are extremely cautious on leverage, focusing on a maximum 50, 55, maybe 60% loan to value. They want to see high occupancy, they want to see long-term leases.

If you have an office property that's 90% occupied by one large tenant that has a lease coming due in two or three years, that's a very tricky scenario. So general Office has definitely been tough. Medical office is one part of the office world that we've seen a lot of interest in, mainly because you need to be physically in the office for a medical procedure, whether it's surgery, an X-ray, or a scan of some sort. There is definitely a move towards telehealth. But the physical nature of being in a medical office is key. So the office market is tricky. General office is tough. Medical office seems to be significantly easier to finance. Secondly, credit standards. Obviously, we've talked about what's going on in the baking industry at length, they're just becoming more conservative. They're lowering leverage. They have higher DSCR requirements. Cash-out is really becoming heavily scrutinized in deposits. Right. So banks are in the business of taking in deposits. Those are traditionally their liabilities. They're going to take in deposits and pay interest on those deposits and then take those deposits, turn around, and lend them out. Right. So if you're a bank and you've experienced a significant outflow of deposits or you're not meeting your liquidity or financial ratios, your number one priority is to boost deposits in order to make new loans.

So we're noticing some lenders require X percent of a loan in deposits, whether it's 10%, 20%, 25%, or 30% of a loan. Some lenders have a dollar minimum. Right. So it might be a larger bank that might require a million dollars or $5 million of deposits. So right now, deposits are key. They open the doors on the lender side to new borrower relationships, and on the borrower side, they open the doors to new lending relationships. So we'll keep an eye on that. But right now, deposits are heavily coveted by these lenders. Lastly, lifeco's rates. These lenders, as we just talked about, these lenders have a low cost of capital. They tend to focus on mid to large-size deals. They're focusing on stabilized assets. They're going to be very conservative with leverage, but they're going to provide very long-term fixed rates, potentially partial or non-recourse, and they tend to outshine the other lenders when it comes to rates, especially when a deal fits within their wheelhouse.

Sure. Yeah. My only comment on the banks continuing to tighten regional banks and credit unions was not a part of that Fed stress test that you were talking about earlier, Chris, those are the 23 largest banks. I think there's been more worry about regional banks and smaller community banks and their levels of deposits. And I think this reiterates that. It reiterates that there's a class of banks unless you're the largest, where they are very worried about their deposit levels and it's affecting their lending. So it means turning over more stones to find the right regional bank that can work with a particular borrower, especially if you're looking for full leverage on a deal. Yeah. So in light of the market conditions, as we turn here, we did recently announce a promotion for Stacksource in particular. And if you're not aware of who we are, StackSource, we are commercial real estate capital markets experts that help real estate investors find debt and equity financing for their deals. We work on small and large deals, complex and simple, for specifically stabilized properties of more than $10 million in loan amount needed. We're actually cutting our usual 1% origination or advisory fee down to 40 basis points.

And this is in place until the next Federal Reserve meeting on July 26. So an application needs to be into StackSource for financing on that date, and it needs to close within 90 days. There are a few more terms and conditions that are outlined here, like being no more than 75% LTV. And this is not for borrowers with distressed credit scenarios, but you have a stabilized remnant of 10 million or more. We're running this 40 bps promotion to help real estate investors in a time when it is difficult to find the right senior lender, even for a stabilized deal. And in light of the Fed pausing short-term rate hikes, we thought this was the right thing to do for the industry and for our clients. So, Stacksource.com for more info there, turning to the months ahead and Chris, I want to get your perspective on this. What do you think are the biggest things to know about the coming months and the capital markets and some of the big question marks out there?

Yeah, I think one of the biggest question marks is the Fed and short-term rates, right? They just paused after ten consecutive increases. There were definitely, if you read the minutes that came out recently from the most recent meeting, there were definitely some differing opinions, right? Some officials wanted to increase rates, others wanted to keep them the same. They ultimately were unanimous in their decision to keep them the same. But that shows that within the Fed there's an interest in continuing to increase rates, ultimately to tame inflation, right? Their job is to bring inflation down to keep employment at sort of full employment. We've had a couple of good numbers. We had a good jobs report come out. We had GDP revised higher. Those are great for the overall economy. And that probably gives the Fed some room to increase further without doing real damage to the economy, as well as potentially keeping rates higher for longer. So that's definitely something that we're going to watch. I know investors here today, as well as those just in the market. This is definitely something that's on their mind and really plays into putting a deal together and how financing plays out.

But yeah, the Fed and short-term rates are definitely on our radar. Secondly, the summer, obviously the summer tends to be a little bit slower. You couple that with what's going on in the economy, a lot of unknowns, potentially increasing interest rates. We just expect a slower summer. Overall transactions have been down, financing has been down. We touched on life. Co. Originations down 60%. That's not abnormal. Given the overall macro environment. I think we're going to continue to see a slow summer. There's still a spread between the bid and ask on a transaction. Sellers still seem to have lofty expectations. Buyers want a deal. So there's definitely that spread in our world. If financing prevents a deal from penciling out for the buyer, you know, that deal is just not going to happen. So, you know, we're gonna we're going to probably see a slow summer, and hopefully as we get some clarity on the economy, on rates leading up into the fall, we might see some more transaction volume pick up. Lastly, refinancing a lot of loans that originated either perm loans that originated 5710 years ago, or bridge loans that were originated 12, 24, 36 months ago.

These loans are coming due. Let's take a perm loan, for example. Rates have come up pretty significantly. Rental growth may not be there. Valuations may have come down. So when a borrower is going to refinance a loan, they might be coming in with an LTV that might be breaching some maximum LTV for a lender or might be not quite hitting a minimum DSCR requirement or debt yield requirement. We haven't really touched on debt yield lately, but the metrics in today's environment are significantly different than they were two or three years ago and even five years ago. So the term cash-in refinance is definitely what we're hearing it a lot, right? So you've got to bring cash to the deal to either lower leverage or lower the loan amount so that the debt service is lower and thus you're meeting certain DSCR requirements. So I think this is going to continue. I think investors just need to be prepared to either find alternate sources of financing, structured finance, which is something we've been pretty successful at coupling with senior loans, or bringing in other pieces of equity. But yeah, the refinance space is definitely going to be tricky and involve some critical thinking on the best ways to put a deal together.

Yeah, and bringing cash to a transaction or doing a capital call on LPs, is always painful. And so some of these other solutions like bringing in pref equity or refinancing to a floating rate, there are other solutions for refinancing that are not a capital call in your LPs or a workout and a blend and extend with your current lender. And so a lot of these are being explored retroactively. C Pace funding is another that is gaining popularity as borrowers are looking at financing options that solve their capital stack, get them to the leverage that does not require one of those uncomfortable moments of an LP capital call, for instance. So I agree there. All right, as we round towards questions and please, if you're watching live, drop some comments in with your questions. If you have a question about something we've talked about or something else in the market you'd like us to address, please go for it. As we wait for questions to come in, a couple of things about StackSource I mentioned, we're expert capital advisors. We're nationwide working on debt and equity placement for commercial real estate deals. We provide competitive terms, and have a network of banks, debt funds, private equity, life cos, and more that are providing quotes on our managed marketplace platform for deals.

And we are the most transparent platform in the marketplace. Not only on the process and seeing the updates from all the lenders you're matched to, but also there's a guarantee that there will never be a hidden yield spread, premium, referral bonus or anything else that happens that gets Stack source paid off of a closing statement which is common in our industry, unfortunately. So we are the transparent platform and all right, let's get to Q and A. So we have questions coming in from live viewers and we have a couple that came in ahead of time. I have a question from LinkedIn. Chris, we're being asked, are floating rates a good option for refinancing in today's market? What are your thoughts?

It's possible. I think rates are going to continue to tick up potentially through the end of the year, but I don't know how much higher they're going to go. I think most of the pain that we've experienced has already been baked in. So taking short-term rates from zero to 25 basis points up to 500 to 525 basis points, was a swift move. I think we're probably going to see higher rates, but I don't think it's going to be at the same velocity that we saw them. And I do think rates are going to come down. One thing I've told my clients, and we've definitely discussed internally here, is does it make sense to fix in long-term financing at this point. Maybe it does, maybe it doesn't. It might depend on the prepay penalty. A short-term bridge solution or a floating rate option may not be a bad idea. In the next six to twelve months you might catch the downslope of rates coming down. So something that we can certainly explore in conjunction with finding other sort of fixed rate options.

Yeah, I agree. If you're in this class of investors and most of the bond market is pointing this way, where you have expectations of rates potentially not coming down this year, but maybe coming down 2024, 2025 at the latest. And that is what the bond market, and like the Fed dot plot, is showing potential decreases in rates sometime in the next 18 months. If you're in that camp, the added advantage of having a floating rate other than your rate can come down 18 months from now is floating rate deals typically come with more flexible prepayment penalties. And if you think your property is going to be in good shape, your business plan is going to be in good shape, and then rates are lower 18 or 24 months from now, that gives you an opportunity to refinance and get that fixed rate if they do come back down to historical lows. So I agree. Yeah. And it's a deal by deal. It depends on what asset class and market we're talking about, and it depends on the health of the DSCR of your property. I think that is really the key. What is your DSCR at today?

And that's going to really dictate a lot of your financing strategy. The floating rate is the answer for many financing scenarios today. I think we have another question from LinkedIn coming in. Are we seeing any trends specific to industrial financing? Chris, I've got a couple of thoughts on this, but what are your thoughts?

Industrial along with multifamily, has definitely been an asset class that lenders prefer over general office retail hospitality. So if it's a strong industrial deal with either single or multi-tenants long-term leases, good market. Yeah, I definitely think it's an asset type that'll get some interest from lenders. Ultimately it comes down to who's the tenant. What does the lease structure look like? How long have they been there? I've personally seen spec industrial development deals and they're surprisingly getting financed mainly because it's a strong market. They might have it pre-leased, or maybe not pre-lease, but in talks with several tenants. So it really comes down to who the tenant is, and what the lease structure is. That would be my opinion right off the bat.

Sure, I will pitch in these industrial properties in most locations across the United States at the moment. You're not seeing the same skepticism that you're seeing on office properties that you were mentioning earlier, Chris, as far as, hey, if I have a lease coming due in two years, it's just going to be an empty building. I don't want to finance something that might be empty. And that's the thought on an office. I don't think you're seeing that for industrial in any sort of area where there's population growth, right? So if there's population growth and there's an area to serve, and this is especially for light industrial, where this is potentially a warehouse for last-mile delivery, we're not seeing the same skepticism on future NOI for industrial properties. They are more easily financeable than many others and they're bucking the trend for commercial property price index overall. As far as just values of properties, industrial is a great place to be if you have any sort of location with a growing population, is my thought. Okay, we do have a question. Another question on LinkedIn is about Libor and the challenges related to transitioning to SOFR.

It is worth mentioning, and we probably should have had it in the deck this time around. Libor has officially sunset. So June 30 was the last day of the useful life of Libor. Now there's going to be some reporting around like a synthetic Libor for some months to come that could be used in loan docs if it was originally Libor based in the US. This is almost entirely transitioned to SOFR, which is a measured rate rather than a surveyed rate for banks. So it can't be manipulated in the same way Libor was. And so all new loan agreements, and for a while most new loan agreements have been written with Sofa. If you had a loan from a few years ago, like a long-term bridge loan, if four years ago you had a three plus one plus one structure and you're now in the first extension of a loan and now you're needing to take the second extension. That's probably the most common. Hey, my loan is still based on Libor. Can't give a generalized answer on what happens. And does that smoothly transition to Sofa without saying you probably. Need to chat with a real estate lawyer at that point, because if it didn't have in its loan docs transition language for what happens when Libor goes away, you're going to need to read the loan docs carefully and also understand the location, the local laws, the state laws that need to be regarded in that particular situation.

If you've been in a bridge loan for a year or two, it's probably already on SOFR or has transition language put in. All right, we do have a few more questions between LinkedIn and YouTube. I'm going to skip over the ones that pertain to specific scenarios or asset classes in the interest of time, and we're going to get one or two more general. If you do have questions about specific asset classes, locations, or financing scenarios, hello@stacksource.com is a great way to chat with the capital advisor, get some thoughts, and that's no obligation to have a conversation with a capital advisor. And then obviously, if we can help place the financing, that's where we make fees on the generalized side, and we'll have time for one, potentially two more. Chris, question from Offline about the significance of requiring deposits at origination. How is that impacting borrowers and lenders? I think you went into this a little bit, but are there any types of borrowers maybe I'll ask this are any of the types of borrowers that are affected by this more than others?

Yeah, one thing we've noticed is if you are, let's say you're a fund or a syndicator and you're bringing on multiple investors and you're raising it's a $10 million deal and you're raising 3 million of equity and 7 million of debt that lender might require, let's say 3 million of deposits right. On a $7 million loan. Let's just use round numbers. For example, if you're a syndicator and you have dozens and dozens of investors and maybe nobody is more than 20% of the entity or the ownership structure, it's tricky. How are you going to meet that $3 million deposit requirement? Are you going to have each investor, sort of on a pro rata basis, pony up that $3 million? Are you going to have one large investor step up and say, I'll make a deposit? Yeah, that's going to be tricky. We haven't really seen many scenarios yet where this has unfolded, but that is certainly a scenario that I envision that could definitely be a hurdle with this new deposit requirement.

Absolutely agree. Even where it's a 20% deposit requirement in regards to the loan amount, it's these smaller, lower middle market syndicators that are going to be hit hardest, and it's making these regional banks uncompetitive for that class of borrower. I think this is really where we're seeing the debt funds step in, because debt funds are not seeking deposits. They have their pool of capital from third party investors that are investing in the debt part of the stack. And they're not banks, they're not seeking deposits. And so I think they're stepping up for non agency where regional banks are not competitive. And if it's not a lifeco asset, it's not class A, it's not in a primary market, it's not conservative enough or it's not the right asset type. If it's something in that space, it might come down to a debt fund execution where you would have otherwise expected it to be a bank execution. A year or two ago. So I totally agree.

Okay, one more. The Fed signaled potential further short term increases. So we had the pause in June. But with the Fed saying that they may still raise short term rates more, how might that affect commercial financing in the coming months?

I think it's going to be more of the same. Right. Some deals aren't going to pencil. I think the slowdown in transaction volume is going to persist, just as we mentioned it might be through the end of the summer into the fall. If a deal pencils today, with today's rates, you know, in 12, 18, 24 months, that deal is going to look significantly better when rates come down and valuations, we hope, start to increase again. But the continued increasing in rates, in my opinion, really just keeps the brakes on transaction volume for the time being.

Sure, agreed. Before we sign off, one more question from LinkedIn is about preferred equity. Mezzanine debt, potential equity credit. Yeah. There are so many different options further up in the capital stack today than just senior debt. So just specifically at Stacksource, we launched as a very simple lender match portal. Online you see your matched lenders, you can get quotes from all of them. We've evolved since then. We have a team of capital advisors across the country, including people like Chris that are commercial financing experts. And we have relationships not only on the pref and mez side, but really to underwrite different scenarios and see what works best for each deal. And there have been scenarios recently where we've introduced clients one to another to even co GP deals together. And so there's a lot of solutions in the marketplace today for equity, or what some might call a debt equity option, where it's something in between debt or equity. And there's some promote, but there's also some debt like qualities. And sometimes that would be a hard prep. There's a lot of capital options out there today. So as we talk, pretty conservatively, or I hope it doesn't sound too pessimistic about what banks and lifecos are being very conservative.

There is a lot of capital out there, but there's a lot of capital that's seeking some sort of upside in addition to having some sort of current pay, whether that's a mez, whether that's a pref. There are some lower cost options further up in the stack too, like a C pace where it's eligible. So there's a lot of capital options out there in the market today. Stacksource, you can put in a property address and some information about a deal online and you can see matching financing options and then have a conversation with a capital advisor to explore what may size out. And it is important to do the right modeling and the right sizing, especially when it comes to prep equity. If you're trying to breach certain hurdles with your LP investors, you need to understand how a current pay. And upside prep is going to affect that. And that's something that's best for a conversation with a Capital Advisor. So hello@stacksource.com is a great way to get in touch with Capital Advisor in your region. You can visit us on Stacksource.com and learn more about our model. That 40 basis point promo is only for simple less than 75% LTV stabilized refinances or acquisition financing.

But for everything else, we have a Capital Advisor standing by to have a conversation. So thank you everybody that joined us live on YouTube or LinkedIn. This replay will be available on our website. Feel free to share it with colleagues in the industry that may find it useful. And you can also download the slides and the data from the deck on Stacksource.com. So, once again, this is Tim and Chris with Stacksource St recapping June. Chris, thanks for chatting with me.

Yeah, Tim, thank you. Thanks everybody. Hope you have a great week and we'll see you guys next month. Bye.

Find the right commercial real estate financing with StackSource by getting instantly matched to the best debt and equity options for your project from our nationwide network of capital sources. 

Our expert Capital Advisors help you secure your ideal capital stack, resulting in a lower cost of capital for your investments in less time and with more transparency than a traditional commercial mortgage brokerage. Learn more at StackSource.com.