May 2023 Capital Markets Recap

Tim Milazzo
June 8, 2023

CEO Tim Milazzo 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.

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

All right. Well, hello and welcome to StackSource’s Commercial Real Estate Capital Markets update. Looking back at May 2023, it is early June. We're going to dive into news, data, and deal structures. I'm Tim Milazzo, co-founder and CEO of StackSource. I am joined by my colleague, Huber Bongolan, Director of Capital Markets at StackSource. And we're going to dive in. Okay, so 1st, May news and events. We have a couple of items related to real estate, but before we get to those, what happened in finance and capital markets overall? Big country-changing news. The first one was the debt ceiling compromise. So US federal government, Congress, & the President reached a bipartisan two-year compromise to prevent a default with the US. Sovereign debt. So the treasury now has an operating budget and a new suspension of the debt ceiling for the next two years. That was dominating financial headlines because it was the value of the US Debt, which used to be considered risk-free. And it gives us two years to operate with a normal open federal government. So with that headline now out of the way with the compromise, back to things like the Fed and what's happening with inflation and economic growth.

So speaking of the Fed, the Federal Open Market Committee did raise their benchmark rate by 25 basis points, and that was in early May, it seems like a long time ago, but this was in May, May 3, they raised it by 25 basis points. There was some broad acknowledgment of negative economic data at the time. There's speculation as to whether rate hikes have ended at this point. And we'll talk a little bit about the months ahead in a few slides. But before we do, two pieces of real estate investment, and Real Estate finance news, Huber, why don't you jump in?

Perfect. So we've been hearing rumblings about these two for a while now, but the data is now out. So for the first one, it comes from the Mortgage Bankers Association which reported a decline in commercial mortgages, and commercial mortgage originations. So about 56% year over year, down from last year, about 42% quarter over quarter down as an industry nationwide. And our second report that came out has to do with CPPI, which measures commercial property values. So the CPPI fell about 9.4% year over year, that is across all product types. And specifically for multifamily, it fared the worst where nationwide values were down about 12.1%.

So now moving on from news and events from the past month, we have a look here at rates where you can see how they've trended month over month. As we all know if you've joined us before, we're tracking inflation in the green, the ten-year US Treasury, two year, as well as term SOFR. So it's a great sign to see that inflation continues to tread trend downwards. And another point of interest is that we still have that inverted yield curve, the ten-year and the two-year which a lot of economists track for potential inversion or normalcy. You'll again notice that it still remains inverted where the two year is still higher than the ten year and that has been true since about mid last year. So we'll be watching for those rates to normalize and the ten-year to start to creep back up above the two-year. But that just has not happened yet. Moving on from rate changes, here's our chart, our graph that goes over all of the different types of lenders and the interest rates, lower bound and upper bound that we at StackSource are typically seeing per lender type.

So this is as of today, we've updated it. You'll notice about eight or so different lender profiles ranging from agency lenders, CMBS lenders, and then of course the hottest lender right now in terms of just in the news headlines, regional banks, credit unions, life insurance companies, and debt funds. These lower and upper bounds are the typical ranges. Now if you're in this market day in, day out, you might be saying to yourself oh, I've seen rates a rate lower than that or maybe higher than that. But these are the typical ranges that these lender providers typically operate between and then of course every deal is very different. So you might see a deal where that interest rate comes in a little bit lower or higher abnormal. But again, these represent the typical lower and upper bound ranges. So moving on from the actual rates that they're providing, what are some updates when it comes to underwriting and deal structure that we're seeing in this past month? So specifically, again, we talked about on the last slide, banks. When it comes to regional banks and national banks, we're showing that they're much more conservative nowadays, they're constrained by internal liquidity ratios.

We're seeing that a lot of banks are asking for depository relationships in order to shore up their own personal balance sheets and strengthen themselves. Again, underwriting becoming much more conservative. Specifically when it comes to cash-outs, they're much more hesitant to give out cash-out proceeds and want to know exactly what it's being used for. And they like it when it's being used to help enhance the collateral, enhance the property. Not so much if it's just being used to pad the sponsor or being used for something else other than helping out the collateral. And then of course we are hearing that banks are either on pause, some are closing shops, closing their commercial real estate divisions. That's news that's starting to dominate our headlines. The second and third bullet points that you see there. While loan-to-value may have constrained us in the past as one of the stipulations you typically see on a term sheet, the DSCR ratio is what is typically constraining us now due to higher interest rates, and this higher interest rate environment. And then lastly, one of the trends that we're seeing when it comes to deal structure is more lenders being open to shorter-term deals.

So instead of locking in longer-term perm rates at seven years, or ten years, at this current high-interest rate environment, you're seeing perm products that are more popular around the five-year term. So that way it gives more flexibility to sponsors and borrowers to be able to refinance when rates are hopefully lower in the future. These are just some of the trends that we're currently seeing. And to discuss a recent closing, I'll pass it back over to Tim.

Yeah. So there's been a lot of focus on multifamily and its propensity to be used in place of old office buildings that either are vacant or are risking vacancy. So weak rent rolls where tenants that do not have much of their physical workforce coming in, are seeing expiration of leases in the coming years. And the idea to turn these old office buildings in central business districts into multifamily is on the surface, an attractive one. It does not work for every size, location, and type of office building out there. Here we did have a couple of our StackSource colleagues arrange financing for a downtown Dallas office building to be turned into a multifamily. So a conversion loan, a $13 million loan that we closed last month. And so this is bridge debt. It's 180,000 square foot office building that's going to be converted ultimately into 238 multifamily units and retail space on the bottom. It takes understanding the floor plan and the bones of your building to understand the cost that is associated with turning an office building into a multifamily. And while we saw and you talked about Huber with the commercial property price index, multifamily has had the steepest decline in commercial property values in the last twelve months.

However, there's still demand for housing. And while multifamily values may be going down, a multifamily at maybe a little bit of an expanded cap rate that has demand and will be fully occupied in many of these central business districts where there's an opportunity for demand on the multifamily side, it's better than a vacant office building, right? And so this is driving that idea with many real estate investors. We have other office-to-multifamily conversions in the financing pipeline as well. Here is one that got done with bridge debt, interest only. And this is possible, but you need to be talking to a qualified capital advisor to talk about what deals, what office deals may be a fit to convert to multifamily, and what that financing might look like, be highly location dependent as well as a business plan. And how much capex really does it take to convert that office building? As we look at the months ahead, in addition to other office buildings and sizing up whether they can be converted to multifamily, you talked about banks wanting depository relationships. There's no surprise that eyes are going to remain on potential bank failures. So we've had a string of some high-profile bank failures we've seen in the stock market.

Bank stocks have performed poorly in the last few months. Even if they're not the banks that have been in the headlines about defaults and FDIC takeovers, it's going to be interesting over the next few months to see how many other banks might fail. What does that do to banks that are peers? And are we going to see a continued shift of depository relationships to larger financial institutions that may be deemed safer? There have been no losses by consumers and small businesses that have used the banks that have failed as far as a depository relationship. But there have been distressed sales of loans starting to come through in addition to losses on equity for shareholders in some of these regional banks. So eyes are going to remain on that in the coming months. Bond investors are very skeptical right now. A pretty dry CMBS market as far as the CMBS CLO market, even more skeptical. So bond investors are hesitant regarding non GSE bonds coming from commercial real estate that don't have those GSE Fannie Mae, Freddie Mac, or HUD guarantees. So as the Federal Reserve makes its plan clear and as more economic data comes out, that can thaw a little bit.

But we're waiting for bond investors to be more excited about CMBS if they're not right now. And finally, another thing we're looking at for the months ahead, is real estate investors are awaiting that same interest rate stability. Will the Fed raise interest rates further? Where will Treasuries net out? Is the ten year going to come back over the two year that informs commercial property values? Commercial property values are falling, but we don't know to what level they are falling. Where will they stabilize? That is when the point when we expect to see more transaction volume. So that's something to watch. Okay, before we open up for question and answer, and please do drop questions in the comments whether you're watching live on YouTube or on LinkedIn, we're StackSource. We're expert capital advisors, a team of capital advisors across the country. We have nationwide reach with regard to commercial properties and financing sources. Our value is that we bring both transparency and competitive terms through our portal for any commercial financing need that our clients have. We mostly serve real estate investors in the middle market and small balance as well. So as we turn to Question and answer, once again, if you're watching Live, if you're watching later, your comment won't help you, but if you're watching Live, go ahead and drop some questions and answers.

We have a few that are coming in. Okay, we have a question about the multifamily conversion from office. How long did it take to close on application? How long we can close on a conversion deal that's a bridge loan in particular, like the one that we showed, is going to be highly dependent on how clear the sponsor's business plan is. And that construction and Capex plan if that construction and Capex plan is clear, it's bid out to construction companies and you have multiple bids back and you have it selected, and it's really shovel ready, so to speak. So maybe we're not going into the ground for new construction, but that construction company is ready to go and it's an experienced sponsor. We're looking at closing these types of conversions within 30 days if they're not ready. And they have a lot to figure out in their capex plan and there's a lot of questions and they're going to need to get entitled with if there's entitlement risk with the city because you're not already entitled and ready to go on the business plan, it can drag out. It's about preparation for the sponsor more than it is.

The capital sources are ready to do these types of conversions and so within 30 days is really reasonable when your plan is approved and your construction is figured out and you have a track record, that makes sense. Anything else to add on that, Huber?

No, that was perfect. Yeah. The better to eat up a deal is and the faster the lenders can perform. A lot of times we're hearing now, it really just depends on the sponsor and how fast they can get them the information they need in order to close.

Right. Cool. Okay, next question. How will the recent debt ceiling compromise, okay, so we're talking about Congress and the President compromising on preventing the US Treasury default, So how does that recent debt ceiling compromise impact commercial real estate, capital markets? What do you think, Huber?

Yeah, happy to kick this one off. I think for me it has to do with market stability. When the market is more stabilized, people are more short of the future, there's more liquidity in the system versus otherwise. If there's more volatility, then you'll see more hesitancy from lenders. But when it comes to the debt ceiling, what we did see in real-time were lenders saying, hey Huber, or Hey StackSource team, we're going to be on pause or we can give you this quote right now, but if Congress doesn't reach an agreement, then all bets are off where these rates are going to go. So we saw a lot of lenders be hesitant to give out quotes until a compromise was met because they just didn't know how severe the impact would be on rates and the market in general. So we're very happy that Congress finally came to a compromise on that debt ceiling issue because it reinforces stability in our industry.

Yeah, I agree. This is a very foundational level that we know that our government's going to be open and that the currency can be used. And that is a very foundational level of market stability that has to be there. Now. This has happened enough times in the last several years. I guess looking back since the great financial crisis of 2008. We've had several debt ceiling compromises that have had to be reached. This one came down to the wire within days of a government shutdown. We've had government shutdowns before. Confidence in US currency over the long term is not what it used to be. But we have to have a base level of confidence that, hey, this year business can be transacted as normal. And that's what this accomplished. So I agree. Okay. Another question with the Mortgage Bankers Association saying that, and to clarify, it was quarter one of the year. So January through March, with quarter one of the year being down 56% year over year, what factors led to such a sharp decrease 56% year over year decline in commercial mortgage volume?

Sure. Yeah. And again, very interesting to see that the data has come out now for Q1, the first three months of the year. But the answer would be market volatility. That was introduced second half of last year. And you're now starting to see the repercussions of interest rate increases. So with these higher interest rates, it's much harder to have deals pencil out. We mentioned in one of the slides that a lot of the loan sizings that we're doing are being constrained by DSCR stipulations, the debt service coverage ratios. And as most of us know here on the call, as interest rates continue to creep up, if your other metrics variables are staying the same amortization credit step of 1.2 or 1.25 if stays constant and your other variable, your third variable of interest rates goes up. Then the output, the loan amount that a lender is willing to lend to you, goes down. So with interest rates increasing, and loan sizings going down, it's making it much harder for sponsors to refinance or get to a purchase price where they can also get a loan in order for deals to be done. So I think those three for me, market volatility leading to higher interest rates, leading to the fear in the market or deals not penciling for me.

Those are three things that caused the mortgage originations to go lower in Q1.

Yeah agree on all that. There's no refinancing volume with the higher rates. The other thing is just this. Nobody wants to catch a falling knife of falling commercial property values if we don't know where it stabilizes out. Six months ago, these conversations were about price discovery. Now it's about price reductions, value reductions. But where does it hit? And you don't want to be the last investor when the prices are just going to go down further. You want to be at the bottom. You want to see prices stabilize out. That's where you acquire and catch them on the way up. I don't think investors felt confident, certainly not in Q1 of this year, that that's where it's going. I don't think they really feel confident about that in Q2. In large part now, there are good value add deals, there are good construction deals. I don't think sophisticated investors are jumping in at a stabilized acquisition with yesterday's price and tomorrow's NOI, that doesn't make a lot of sense. The falling knife, avoiding catching the falling knife is a real trend here with the banks pulling back huber. What alternative sources of capital or financing or other types of lenders are taking their place?

Right? Great question. That's a question that a lot of our teammates here at StackSource are getting asked by their clients. And you're starting to see a lot of these alternative sources prop up that maybe weren't as popular before, but now that the senior loan is being sized a little bit lower and being constrained these days, then you're seeing our clients ask for these alternative sources. So these include such products as ground leases. C-PACE is a big one, especially for construction deals where we're seeing preferred equity or mezzanine debts being used as gap financing in between the sponsor's equity and the senior loan in order to help fill more of the capital stack. And then, of course, debt funds being coming into play and being used more in order to provide more traditional transitional financing for deals that are not quite ready for perm. So ground leases, C-pace, mez, pref equity, debt funds, these are all alternative sources of capital that aren't senior loans that we're starting to see more structured financing these days and our sponsors needing them in order to fill the capital stack and do their deals.

Yeah, it's interesting to see C-pace not only for new originations with new senior loans, but the chatter on our team about retroactive C-pace where you already have senior debt. You didn't get C-pace as you originated. If you're a bank that knows the value of that property that I lent on is falling, the NOI may be falling. It's a DSCR that's more than one, but it's less than the 1.3 or something that I'm comfortable with. And the sponsor needs additional capital for whatever reason, or they don't want to refinance out. Maybe you're in a technical default. If you didn't prefer the idea of C-pace being in the capital stack before, might you yield and allow a retroactive C-pace to come in to solve some problem with the property or supply some capex dollars or something? I think you're going to see increasing lenders consider allowing it to avoid a true financial default when you're in technical default. I think that's another we probably could have mentioned that in the months ahead, but I think to mention that now and alternative sources of capital, it's an interesting one that is being underwritten on some deals in our pipeline right now, I think.

So that's another interesting alternative. All right, well, I don't see any more comments with live questions coming in. If you have questions about your specific property or deal scenario, the best contact info will be You will be put in touch with one of our capital advisors that is, knowledgeable with that asset type deal scenario and location. We have a team of capital advisors across the country. If you want to see our commercial mortgage rate table in a way that's really easy to read, copy it if you want to see it updated today. If you're watching this later, you go to and you go to Rates. Other information about Stacksource and our financing platform is there as well. And we are still expanding our capital advisory team. So if you're looking for your next best role in commercial real estate finance, your experience with this stuff as a real estate investor, lender, or commercial mortgage broker. If you're a commercial mortgage broker, you really should be upgrading to being a capital advisor. Get on the same side of the table as your client. Help people. Help them bring solutions to the table. Don't be beholden to one balance sheet that you're trying to sell. Give your clients the best access to capital on the market. That's my little plug for StackSource because that's who we are. And these are free. Hope you enjoyed it. This is our May Capital Markets update. We do this every month on LinkedIn Live. Huber, Thanks for helping out with this.

Absolutely. Thank you, everyone.

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