KANSAS CITY, Kan. (Feb. 21, 2023) — Greg Duvall, managing director, and John Duvall, vice president of Northmarq's Kansas City debt/equity team provided France Media's Heartland Real Estate Business with responses for their 2023 Lender Insights. The special section features direct lenders and financial intermediaries from across the region who cover the challenges and opportunities in the year ahead, factors most affecting the lending environment and the property sectors to watch during 2023.
Heartland Real Estate Business (HREB): What is the biggest challenge you anticipate in 2023 as a direct lender or financial intermediary in commercial real estate?
Greg and John Duvall: Uncertainty about how long it will take the Federal Reserve to tame inflation is disrupting what had been a heavy volume of sales transactions in commercial real estate. Time lags between Fed rate increases, and corresponding reductions in economic activity make it hard to determine when the Fed should take its foot off the brake. Therefore, buyers and sellers can't easily predict when mortgage rates will begin to decline. Until there is a consensus among real estate investors, we will likely remain in a period of price discovery, which typically means fewer sales transactions. Lower sales volume will be a challenge to mortgage lenders, particularly those without large servicing portfolios that typically provide lenders with a good supply of refinance opportunities as loans mature.
HREB: Are commercial real estate borrowers more interested in fixed- or floating-rate financing today versus a year ago and why?
Greg and John Duvall: A smaller portion of the loans Northmarq has signed up since Jan.1, 2023 are floating-rate financing compared to January 2022. Part of this has to do with a flight to security. The average SOFR (commonly used as the index for floating-rate loans) has moved up over four percent in the past 12 months. The Fed has indicated a desire to slow the increase, but no timeline as to when it will actually start decreasing rates. As such, borrowers seem to be willing to endure the "high" fixed-rate note rates we are currently seeing rather than risking potentially even higher floating-rates in the near-to-medium future.
HREB: Are there any common questions you are fielding from borrowers today, and if so what are they and what advice are you giving them?
Greg and John Duvall: "When will interest rates start going back to normal?" What is normal? We are well above the previous three-year average for the 10-year Treasury yield, which is 1.79 percent. But we are still below the 30-year average of 3.83 percent. Instead, I think the better question is "When will the United States get inflation under control?" Inflation peaked at 9.1 percent in June 2022. Though it slowed to 7.1 percent in November (and an estimated 6.5 percent in December), we are nowhere near the 2 percent average inflation rate we have seen for the past decade. Only when high inflation has been completely curbed can we start to see rates decrease. Barring another recession combined with unforeseen extraordinary circumstances (i.e. pandemic), rates may never go back down as low as we were in the past couple of years.