By: Michael Chase, Senior Vice President
The annual Mortgage Bankers’ Association Commercial Real Estate Finance and Multifamily Housing Convention took place earlier this week. After meeting with numerous capital courses and market participants, here are my biggest takeaways from this year’s convention.
Continuing a long running trend, life companies once again have plenty of capital for commercial real estate. Every life company we sat down with is looking to do more in the upcoming year.
Lenders looking to increase their holdings in commercial mortgages in 2016 and 2017 often had to first replace the runoff in their portfolios from maturing loans dating back to the peak origination years of 2006 and 2007. Even though, according to the MBA, maturing commercial mortgages for non-bank lenders is expected to drop 42 percent from 2017 to 2018, the appetite for commercial mortgages has not decreased. With less runoff in their portfolios, balance sheet lenders are viewing this as a prime opportunity to make gains in their commercial mortgage holdings.
The question is where the volume will come from. With less maturing loan volume to compete for, life companies will have to depend on financing transactions or look to early refinances and properties coming off construction or bridge loans. There may also be some opportunities for borrowers to request “top off” funding if their loan balance has reduced and/or the value of their property has increased enough.
Similar to last year, many life companies are being aggressive out of the gate as they look to fill large allocations and lock up the best deals. Aggressive pricing will be available so long as alternative yields in the corporate bond market remain low. Ultra conservative Class-A assets in A locations with A sponsors can potentially see spreads at or even below 100 bps over treasuries. However, the majority of transactions will likely fall somewhere within a range of 125 bps to 180 bps depending on loan size, leverage level, asset quality, location and strength of sponsorship. Spreads at the low end of the range have certainly compressed; however, not enough to fully offset the recent rise in treasury rates.
Life companies are able to offer fixed rate terms of 5-years to 25-years, and in some limited cases all the way out to 30 years or longer.
Have an upcoming maturity that is still 9-12 months out, and don’t wish to pay a heavy prepayment penalty on the current loan? For some additional spread several life companies can provide forward rate locks to help mitigate interest rate risk. This is allowing them to tie up business ahead of other capital sources such as banks or CMBS.
While spreads on conventional loans continue to tighten, several life companies are seeking opportunities for higher yields. One of the primary themes of the 2018 MBA CREF conference has been the increased availability of bridge capital. A few life companies had bridge programs in 2017; but the pool is certainly growing larger in 2018. Life companies are generally entering the bridge space seeking deals with some in-place cash flow and able to offer attractive rates in the range of 300 bps to 400 bps over LIBOR. There are also participating loan programs and JV opportunities available as well.
Continuing a trend from 2017, multifamily and industrial remain a close 1-2 when it comes to preferred asset types for the life company portfolios.
Agencies (Fannie Mae & Freddie Mac)
Agencies once again hit new levels of record production in 2017 with Freddie Mac originating $68 billion, up from $56.8 billion in 2016, and Fannie Mae originating $67 billion, up from $55.3 billion in 2016. Back in November of 2017 the Federal Housing Finance Agency announced a slight reduction in the lending cap for both agencies from $36.5 billion in 2017 to $35 billion in 2018.
It’s easy to see that both agencies have been able to do a significant volume above their stated lending caps by financing affordable and green transactions that qualify as uncapped business. Both agencies are back in 2018 looking to add on to a wide range of product offerings which includes affordable, green, mod-rehab, pre-stabilized and credit facilities.
Spreads have tightened for both agencies as they look to lock up business and get an early jump on 2018.
The CMBS market is looking to build on the momentum of a strong 2017. With the implementations of Reg A/B and risk retention now in the rear view mirror, CMBS volume was able to hit a post-recession high water mark of $89 billion in 2017. The industry is hoping to match the volume in 2018, but like other lenders, they will have less refinance business to rely on to hit their goals.
Overall leverage in pools being brought to market continues to be kept at around 60 percent LTV. In some cases pools are being constructed with a “barbell” effect where smaller transactions below $30 million leveraged up to 75 percent LTV are offset by larger loans in the 50-55 percent LTV range.
Perhaps more than any other lender type, average spreads for CMBS deals have compressed considerably. The pricing range is now starting at around 150 bps over SWAPS for very low loan to value and high debt yield transactions and can go all the way up to 220 bps for full leverage loans with lower debt yields. CMBS is now in a place where they can be more price competitive with portfolio lenders for loans at 60 percent LTV with a debt yield of 9 percent or higher; but their niche remains being able to provide borrowers with an opportunity to get the highest leverage on a non-recourse basis.
As the number of investors in CMBS paper grows and the pool B-piece buyers continues to evolve, spreads could continue to compress as the year goes on.
Touched on earlier, one of the major themes of this year’s MBA CREF conference is the number of alternative capital sources which seems to be growing by the week. Private debt funds, high net worth individuals, mortgage REITS and crowd funding platforms are all entering the commercial mortgage market offering borrowers everything from alternatives to traditional bank financing to bridge, construction, mezzanine, preferred equity, joint-venture and hard money solutions.
Pricing ranges widely depending on the risk profile of the deal and the requested loan term. For example, borrower’s looking to close quickly without a financing contingency in their purchase contract could use a placeholder loan to close in as little as a few weeks for a loan term as short as 30 days at rates from eight to twelve percent.
The bridge loan space appears to be the most crowded and competition has helped to reduce pricing. While there are some fixed rate options available in the bridge loan space, most of the deals are still being done on a floating rate basis and a smart hedging strategy with the purchase of interest rate caps can help save borrowers significant costs.
Interest Rates & Regulations
The risks for a potential regulatory shock to the commercial real estate market appear to be relatively low heading into 2018; however, there are a few things to keep an eye on. Tax reform has been generally viewed as a positive for the commercial real estate industry, but as they say, the devil is in the details which are still being flushed out. States who may have felt burdened by aspects of the federal tax reform may also look to implement changes to their state tax codes. There is also a potential for reform of Fannie Mae and Freddie Mac which the residential and multifamily market will certainly be keeping close tabs on. For now though, none of these appear to be providing any major headwinds for the industry.
The biggest concern for most market participants will be what happens with interest rates over the course of the year. With significant movements in treasuries already since the start of the year, borrowers have seen their cost of capital increase even while spreads have compressed. While interest rates and cap rates are not directly correlated, the industry will be watching closely to see what affect rising interest rates may have on property values, and especially if they will lead to a significant reduction in sales volume.
You can follow Michael on LinkedIn at: linkedin.com/in/MJChase