The Real Estate Capital Scoreboard® – July, 2023

Chicago, Illinois, July 1, 2023 – The Federal government averted last month’s financial shutdown while wrestling with strong labor market conditions.  After ten unprecedented rate hikes spanning two years, the Fed decided to keep benchmark rates unchanged.  But facing a 4% inflation rate, policymakers warn that interest rates will be raised twice during the remainder of the year to tame inflation.  Bond investors react accordingly by widening the inverted yield curve by more than twenty basis points, portending recessionary conditions.

With real estate capital markets in a state of flux at the half-year mark,  the following funding conditions exist:

Higher Rates and Spreads:  In the past month, the 5-year treasury climbed by about 30 basis points, while the benchmark 10-year note rose at about 15 basis points.  In addition, key permanent lenders, including the agencies, increased spreads by 15 to 20 basis points for fixed and hybrid loans.

Restrictive Construction Lending:  Construction loans for nearly all commercial real estate projects, including multifamily, are extremely difficult to obtain.  Regulators require banks to maintain strong liquidity ratios to provide ample cushions against additional rate hikes and potential CRE principal repayment issues upon completion.  Select smaller regional banks and institutional investors offer construction debt under extremely conservative parameters, with pricing often starting above 8%.

Debt vs. Equity:  Mezzanine financing remains popular with funding sources.  Mezz debt is priced better than equity, yielding lower-to-mid teens or more.  Five-year term loans garner the most attention as borrowers shy away from longer-term debt, often priced over 7%.  Alternatively, extremely prime fixed-rate debt based on LTVs below 50% starts in the 5% range, with 6% or more is much more common.

Loan Maturities:  Given the massive volume of debt originations during 2013 and 2014, many ten-year loan maturities are due over the next few years.  And with declining property values (particularly office), lenders and borrowers alike brace for tough refinancing conditions and possible defaults.

Valuation Disconnect:  The public markets (REITs) show substantial property value deviation (discounts) from private markets.  Often, public pricing historically overstates actual market impacts during high volatility cycles, as seen today.  However, given the lack of private market transactions, numerous investors believe actual values are probably about 15% to 20% discounted from peak levels, as current debt pricing and availability remain problematic.

Mr. John Oharenko, Director of the Real Estate Capital Institute®, advises, “Record low unemployment and inflation above the Fed’s targeted 2%-range keep investors on edge for more rate hikes, even as CRE markets remain stagnant.”

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