By Jason Scott
The commercial real estate arena, like the economy at-large, is experiencing some softening.
Of the biggest issues today for both buyers and sellers of commercial real estate are valuations. Rising interest rates have led to negative leverage and buyers simply cannot pay what they could several months ago for a real estate asset. As a result, some have gone back to the negotiating table and transactions have clearly slowed.
Many are asking about the availability of finance amidst all of the uncertainty. While lending hit record levels during the first half of the year, it has slowed. The Mortgage Bankers Association (MBA) stated in early October that it expects total commercial and multifamily mortgage borrowing and lending to fall to $766 billion this year, down 14 percent from 2021 totals ($891 billion). MBA does however predict a rebound in 2023 lending to $848 billion.[i]
A review specifically at the country’s biggest banks aligns with MBA’s outlook. After record lending during the first half of the year, bigger institutions have certainly become more selective with commercial real estate finance deals. According to Federal Reserve data, U.S. regulated banks financed a record $316 billion of new commercial real estate loans in the six months through June, up 172% from the same period in 2021. Banks were so active during this period that their current slowdown in lending activity is conspicuous.
In addition to rising interest rates, the heightened regulatory environment for banks is contributing to this decline. This summer, regulators informed all U.S. banks they will be watching commercial real estate loans closely through the end of the year in an attempt to quell delinquencies. Examiners are honing in on newly issued loans, those considered riskier categories (for example office, hospitality and retail), as well as those vulnerable to rising interest rates.[ii]
Banks have also been keeping more debt on their balance sheets, with today’s interest rates slowing the issuance of new commercial mortgage-backed securities. A recent Trepp report noted that domestic, private label CMBS issuance slowed sharply in the third quarter as market volatility and higher interest rates stifled lending volumes. At the crux of the slowdown again are climbing interest rates. Trepp notes that the yield from the 10-year Treasury (a benchmark for pricing loans) climbed to 3.62 percent (as of October 6th) and from 1.76 percent at the start of the year. At the same time, yields required by bond investors from their investments have increased, complicating accurate pricing for loans destined for securitization and stymying borrower demand.[iii]
Borrowers seeking debt amidst these conditions will be met with more challenges than they have in recent years. In general, they should expect interest rates to continue rising and be prepared for lower leverage. They’ll also likely need to bring more equity to the table in order to access debt. While there is still finance available, there are fewer active lenders today and, therefore, less options. If you’re a borrower and you get a reasonable term sheet from a lender, you may want to take it, as liquidity is drying up quickly.
About the Author
Jason Scott is managing director and head of conventional loan production for Regions Bank and Sabal Capital Partners. He may be reached at Jason.Scott@Regions.com.
[i] MBA, Commercial/Multifamily Lending Expected to Fall in 2022 Due to Ongoing Economic Uncertainty, October 3, 2022, https://www.mba.org/news-and-research/newsroom/news/2022/10/03/commercial-multifamily-lending-expected-to-fall-in-2022-due-to-ongoing-economic-uncertainty
[ii] CoStar, Banks with Bulging Commercial Real Estate Loans Face Extra Regulatory Attention, October 11, 2022, https://product.costar.com/home/news/shared/1070929165?utm_source=newsletter&utm_medium=email&utm_campaign=personalized&utm_content=p1&t=eyJhbGciOiJIUzI1NiIsInR5cCI6IkpXVCJ9.eyJjb250YWN0SWQiOiI3NzQ4NTUyMSIsImN1bHR1cmVDb2RlIjoiZW4tVVMiLCJpYXQiOjE2NjU2MDU4MjZ9.qqNxdQx6Pu3tMI3i_CMbD0c_az9WQApl4pNyE6UxtVA
[iii] Trepp, Volatility, Climbing Rates Push CMBS Issuance in 3Q Lower, October 6, 2022, https://www.trepp.com/trepptalk/volatility-climbing-rates-push-cmbs-issuance-in-3q-lower