[Illinois Real Estate Journal, February/March 2022]
Capital is out there, and developers are hunting it as the Illinois commercial real estate market rebounds from a challenging couple of years.
“Financing requests have fully returned and in some cases exceeded pre-pandemic levels,” says Igor Zhizhin, principal at American Street Capital, LLC. “Most interestingly, the appetite for acquisitions or cash out refinancing to acquire additional assets in the broad housing sector has outpaced many expectations especially in the context of a historically high lack of predictability and with most markets offering historically low cap rates.
He adds that the combination of tangible inflation growth and the broadly believed impending interest rate increases appears to have been far more impactful in driving sizable finance request growth than any of the potential market risk factors.
“Until there is a historically large and sustainable correction or the Federal Reserve publicly commits to a static, multi-year interest rate policy, the appetite for financing has very few deterrents in the near term,” Zhizhin predicts.
Susan Blumberg, managing director and senior vice president with Northmarq, is also keeping an eye on floating rate loans, bridge loans, cap costs and swaps.
“Volatility in the treasuries and rising interest rates will come into play with ability to leverage transactions,” she says. “Refinance risk will be looked at closely and we expect the costs to increase until we see stability in the rates.”
The result is a very competitive lending market, which Associated Bank Senior Vice President and Senior Regional Manager Greg Warsek describes as a “borrower’s market.” Despite the pandemic, Associated Bank Commercial Real Estate posted a record year in 2021, closing $3.6 billion in new CRE commitments. That exceeded the pre-pandemic 2019 record of $2.9 billion.
“We continue to be awarded a high level of loan requests at Associated Bank since we meet and exceed our customer’s number one need, which is ‘Certainty of Execution,’” Warsek says.
“The current lending environment has maintained the strong commercial mortgage momentum of 2021 with the caveat of a more conservative posture towards floating rate structures and short-term products,” says Zhizhin.
Borrowers, adds Blumberg, are expecting significant rent growth and will capitalize on that in the future.
“We have also done our fair share of long-term permanent loans, seeking to lock in those historically low interest rates,” she says. “Anyone who could refinance now to capture the rate has done so. This trend should continue as rates are still quite low.”
Which sectors are fueling that demand? One answer came back consistently: multifamily.
“Housing needs and prices have been rising to a level not seen in quite some time. Occupancy levels are at high levels, which support rent growth,” Blumberg says.
According to Zhizhin, COVID established a consensus that outside of housing all other real estate sectors are highly susceptible to quickly turning obsolete.
“Traditionally predictable asset classes such as retail, office, hospitality, and industrial all experienced substantial losses in the past two years across all markets. This has driven a retraction from many lenders toward more conservative loan terms and structures,” he says. “Even within the housing sector, subcategories such as student housing and senior housing have suffered during COVID with a reduced access to desirable lending options. The multi-unit housing sector, particularly affordable and workforce housing, have become the primary focus for lenders because regardless of geopolitical or economic factors, housing tenants do not have alternatives to having shelter.”
Zhizhin calls the large divergence between traditional commercial and housing in access to competitive, high leverage capital “impossible to ignore.”
“Until COVID no longer impacts travel, employment, leisure, and purchase decisions we do not see a change in the virtually limitless appetite for investors and lenders to have housing as their primary commercial real estate asset class,” he says.
Build-to-rent communities are an exploding asset class with significant pent-up demand, according to Warzek, who also dubs industrial as a dominant market class. Blumberg agrees, adding that NorthMarq has seen an increase in construction in major distribution centers.
“The pandemic created the shop-from-home market and industrial space is in high demand at historically low vacancy rates,” she says.
Developers looking for capital still need to be able to prove to their chosen lender that they have experience, solvency and income predictability.
“Experience has become the biggest driver for most lending decisions rendering it very challenging for first time investors or out-of-market operators to consistently secure competitive loan terms,” says Zhizhin.
A relationship is also an important factor for Warzek’s team as they consider a loan request.
“Is the sponsor someone we want to do business with and develop a relationship over time (and vice versa)?” he says, adding that Associated Bank looks very closely at the sponsor’s expertise in its asset class and the financial strength and backing they bring to the transaction.”
Blumberg adds that an evaluation of competition, new supply and trends in each market is also part of each loan’s assessment. Another caveat, she says, is that it is important for the borrower to have equity in each deal, unless they have a long-term basis in the property.
“Overall, this is a great time to finance properties when rates are low and the economics are positive,” says Blumberg. “There is a lot of capital out there, chasing yield and good deals. Properties are enjoying quite favorable performance and stable occupancy, all while growing rents. 2022 is a new year and predictions are for continued growth.”