Capital Markets Overview: A Look at the Current Environment and Opportunities Going Forward
Coming off the heels of the commercial real estate conference season, the industry seems to have arrived at a consensus: opportunities are available for those willing to search for them and that search may be getting a little bit easier. The expectation is for more clarity from the Fed as the spring progresses, and accordingly, we anticipate that from summer until the end of the year, we will see strong transaction volume.
Retail lending becoming attractive
One of the key takeaways from recent conversations generated with lenders was that nearly all of them are actively seeking retail loan opportunities. Improved indicators, such as occupancy and overall rent, have resulted in more favorable underwriting in the sector. The improved conditions are a result of limited construction in certain markets coming online in the last five years. This has made the environment more palatable for life company lenders to re-enter the space, and also allow for strong execution with commercial banks, credit unions, and conduits.
Adaptive reuse has emerged as an in-demand space. Conversions to mixed-use, lifestyle, and fulfillment centers have resulted in maximization of a retail asset’s value and best use. This translates to more institutional equity providers willing to assist developers in capitalizing on these opportunities. The retail sector does have its headwinds, however, with two consecutive quarters of declining activity noted in the single-tenant net lease sector, as well as a similar pull-back in multi-tenant retail.
Multifamily remains in demand
For the past decade, one of the safest bets in commercial real estate has been multifamily, and that doesn’t seem to be changing any time soon. The best spreads for the multifamily asset class continues to be delivered by agency and “heavy-mission” orientated projects. The arena remains dominated by the agency lenders, but we have seen the popularization of long-term take-out financing by life company businesses. High housing demand doesn’t show any signs of subsiding, so this stalwart of the industry should remain king for the foreseeable future. For multifamily, lenders across the board have significant capital to deploy and are expected to compress spreads, thanks to aggressive underwriting, in an effort to generate more activity.
During the recent National Multifamily Housing Council (NMHC) event, Freddie Mac noted an increase in activity, thanks in part to the massive success of their 5-year fixed rate product with flexible prepay. This product also allows them to achieve higher interest-only levels versus when they had been previously constrained by the shorter loan term. The 5-year fixed rate product also offers a strong alternative to a bridge loan for a borrower.
At the same conference, pipeline building was the consensus from Fannie Mae, where volume has been slower year-to-date than in previous years. Borrowers can benefit from Fannie’s aggressive stance on longer term business (10+ years) and 5-year term options. The agency also communicated an appetite for credit facilities, a possibly unpassable consideration from the right type of borrower. Both Fannie and Freddie reported strong new deal inflows, with a tick-up of conversion expected after an anticipated drop in the 10-year treasury.
Other lending sources are available for specific situations and conditions. Life companies have been aggressive on spread reduction, banks are offering attractive terms for developers seeking construction loans, and equity remains available, especially preferred equity, when proceeds are falling short in a refinance. Additionally, bridge spreads have seen a significant drop in the early part of February, with some exceptions among banks.
Update from the Federal Reserve
We saw the Federal Reserve raise the Fed Funds policy rate by 25 basis points to between 4.50 percent and 4.75 percent during the February 1 meeting. While this was a smaller increase than the 50-point increase seen in December, it is now clear that ongoing increases would still be required to meet their mandate of price stability. The good news is that weakening demand exerted downward pressure on inflation in the previous quarter, making the possibility of this mandate being realized sooner rather than later a real possibility. But as the data changes, we can be sure that the story has not yet been written in terms of next steps.
While the question of “How long will rates continue to elevate and then level-off before rate cutting is initiated?” remains to-be-determined, it is clear the Fed actions will determine the course of the economy during the next one to two years. As a financier, setting a benchmark for rates has been the biggest hurdle due to increased cost of capital which has exasperated by limited clarity around monetary policy. Once uncertainty is eliminated, executions will increase.
As always, the best possible outcome can only truly be achieved by a full understanding of the entire capital stack, especially when pricing and discovery-related questions abound. We see the dilemma of “wait or act now” playing out in real time with borrowers, and the best way to navigate this quandary is to research all available lending options. The opportunities are there, but not as low hanging as they once were.
