So much for a summer slowdown. The return of rate volatility has put the market on edge again right as vacation season is in full swing. The rapid shift from relatively stabilized conditions and improving benchmarks after the initial cessation of hostilities in the Middle East has shifted back to a highly volatile cycle dynamic directly tied to renewed conflict and the disruption of global energy markets. Since June 1, we have seen a 24bps jump in the 10-year treasury yield and a 28bps increase in the 5-year. Dramatic. This volatility could continue climbing before maxing out, with expectations that the Federal Reserve will also be raising rates before year end as persistent inflation remains a long-term concern.
At the same time, we continue to mostly see healthy or improving performance across CRE asset classes and highly liquid debt markets, particularly here in my home market of Kansas City and other nearby key Midwest markets like St. Louis. Still, in a cycle where debt service capacity is key to loan sizing, this rate surge will have impact. Take heart. This maybe a tough shift but is by far not the toughest rate climate for CRE financing I’ve seen during my career. Having survived a few previous challenging cycles, I feel like there is some relevant clarity to offer for focus during this disrupted summer season.
Mark Reichter, Gantry
Lender Liquidity
Unlike other past challenging market cycles, access to a wide range of well-capitalized, active lenders with a variety of programs and targeted allocations seeking out qualified loans sustains a competitive marketplace for borrowers. The sheer volume of lender liquidity still active in the marketplace today is heartening. Competition amongst lenders continues to compress spreads and that is likely to continue for the right assets maintaining stable performance. As valuations have aligned in the current marketplace with the higher rate climate we have been dealing with since 2022, debt pricing can still meet most requirements when the full market is surveyed, and underwriting can check the boxes for the right loan.
Rate Climate
Volatile rates make no one happy, but we are still in a functioning marketplace. Rate volatility has the potential to impact anticipated proceeds and sizing for maturities and pending acquisitions, especially for assets underwriting to the last available dollar. CMBS will be particularly vulnerable to dramatic last-minute rate shifts at closing which could have material impacts on final proceeds. At some point later this year, we should also expect to see an increase to the Fed Funds rate. Geopolitical conflict is not systemic failure, but it is a disruption to the system. Expect there may be a need for fresh equity to right size new loans refinancing assets exiting a lower rate or to align acquisitions with debt service capacity.
Timing is Everything
Timing has become a critical link to financing success in the current market cycle, but not in the way you may think I mean. Start early and research options thoroughly. If your transaction underwrites at current debt service capacity, eliminate the jeopardy and lock in your rate and terms at the earliest opportunity. Waiting for a hopeful rate window to enter the market will only leave you vulnerable to the pain associated with lagging in the face of the unknown. Approaching lenders that lock rate early in the process is the clearest route to stability.
Life Company Advantage
Life companies have remained a consistent and active force in the markets. They have increased their allocations to CRE lending to begin the year and have yet to pullback on those commitments. Their key advantage in a volatile rate climate? Life companies will lock rate at application for loans on quality assets, taking rate pressure off the table. They will compete on spread to improve pricing for the right assets. Where performance supports, partial or full-term interest only terms are also available. Most importantly, once under contract, their certainty of close is a time-tested reliability even in the toughest of markets.
Regional Banks Return
Regional banks are back and busier than ever chasing new loan production. That can bode well for borrowers in the right circumstances. Their local expertise can make them a valuable source for loans on assets outside the primary markets. While they remain a recourse lender and can often require deposits and performance covenants, their flexibility allows them to structure creative options for the right borrower. This can include prepayment flexibility, interest only terms, and competitive spreads for their preferred clients.
Agencies Flush
For multifamily borrowers, the agencies (Fannie/Freddie) remain active with highly attractive loan programs for stabilized assets and affordable properties. Both GSEs are operating from expanded caps and are still aggressively competing for loans with the life companies and banks on stabilized multifamily properties. While not known for servicing flexibility or process ease, their non-recourse permanent loans are appealing for maximum proceeds on qualified properties and can include interest only terms and/or competitive spreads. They reserve their best terms for properties meeting their affordability mandate.
Debt Funds and Bridge Loans
For assets still in transition or sponsors seeking to effectively fund a value-add acquisition, debt funds remain open for business competing with life companies and banks for bridge loans and ready to fund other non-conforming loans. In this highly liquid marketplace, more debt funds continue to enter the marketplace offering competitive advantages and distinct regional or asset specific business models. The key is working with vetted sources. Institutional debt funds, family offices, and private equity all see attractive yield adjusted returns in commercial real estate lending and continue to be an accessible alternative to the primary balance sheet permanent lenders.
The Takeaway
If I am offering one takeaway from this overview, it would be this: stay cool and focused this summer. Where access and options exist, solutions will follow. Commercial real estate financing is a lift even when times are good when you seek to optimize outcomes. The key in any market is to expect the unexpected and plan accordingly. Move up your discussions. Engage the full market. Do it at the earliest opportunity. Survey viable options and make sure you have documentation ready. Rates are not the only factor leading to a successful financing. Discipline, preparation, and performance still matter in achieving the desired results.
Mark Reichter is principal in Gantry’s Kansas City, Missouri, office. He has 25 years of commercial real estate lending experience, having previously worked for a life insurance company, a CMBS lender and a national mortgage banking firm.
