Chicago, Illinois, June 1, 2023 – The Fed’s quarter-point interest rate hike earlier this month marks the tenth-rate hike since the start of 2022. And more negative news about slowing housing markets, lower rent increases, and the ongoing malaise plaguing the office markets. Yet, real estate capital markets continue functioning, albeit at a slower pace based on the following debt underwriting trends:
Loan Proceeds: Debt service coverage (“DCR”) remains one of the most important underwriting variables due to the extraordinarily high mortgage rates compared to recent years. The new theme for property owners seeking debt focuses on “cash in” vs. “cash out” refinancing. Said another way, borrowers must contribute additional cash to pay off an existing loan. The goal is to recapitalize overleveraged debt based on using debt service requirements. Mortgage rates have often doubled compared to the original loan underwriting structured during the past decade.
Floating Rate: Floating rate deals now price at 200 to 300 [or more] basis points over SOFR, translating to 7% or more. Higher rates for value-add and higher-leverage (>55% LTC) are priced over 8%. In particular, construction loans are difficult to find based on the shortage of active lenders in the market, mostly banks. Regulators heavily monitor this funding sector. And since banks carry about half of all commercial mortgage maturities which mature this year, burdening on stressing balance sheets.
Fixed Rate: During the month, five-year benchmark rates climbed nearly fifty basis points, while the ten-year rate increased about as much. The best mortgage rates start in the low-5% interest rates for five-year debt. Longer-term debt is priced in the 6%-or-more. Life companies have become much more competitive in the shorter-term, fixed-rate debt, providing financing options traditionally led by banks, of which many are sidelined.
The Real Estate Capital Institute director, John Oharenko, predicts, “As more lenders remain shy about offering competitive debt terms, seller-financing will gain momentum for closing sales transactions.”