Despite potential rate hikes ahead, lenders have abundant capital and a big appetite for CRE assets.
SALT LAKE CITY, UTAH (January 31, 2022) - We’ve experienced dramatic and remarkable events over the past two years that impact the commercial real estate markets. Pandemics, shutdowns, mandates, multi-trillion-dollar stimulus packages, eviction moratoriums, civil unrest, presidential election turmoil, the great resignation, supply chain issues, and more. And through it, total commercial real estate debt increased $213 billion and $238 billion in 2019 and 2020 respectively for a total of $450 billion. And total origination volume was up 60% in 2021 over 2020. Through all the noise our industry produced fantastic results.
Total commercial real estate debt now stands at about $4.15 trillion. For context, total commercial real estate debt hovered around $2.5 trillion for five years from the early stages of the great recession in 2008 through late 2013. Since, the U.S. has added a staggering $1.6 trillion in outstanding commercial real estate debt. That data point alone tells the story – that there has been and continues to be a huge demand for commercial real estate assets across the entire capital stack.
A continuing trend was the concentrated flow of capital to multi-family and industrial properties driven by housing shortages, and an accelerated changing retail environment towards online merchants. And, a tepid demand for office, retail, and hospitality due to lingering challenges facing those sectors continued. Lenders remain selective on retail as the industry continues to struggle with clicks vs bricks dynamics exacerbated by Covid restrictions. Office is hampered by the slow return-to-work and uncertainty of how hybrid working will impact demand for space. Hospitality was hardest hit in 2020. Although there has been notable recovery, performance remains uneven depending on the market and hotel niche.
An emerging trend in 2021 that we expect to continue in 2022 was the surge in higher leverage floating rate full-term, interest-only acquisition bridge loans in the multifamily space. That activity runs contrary to typical patterns where buyers go “long and strong” when very low fixed rates can be locked in for many years. Buyers have preferred the much higher leverage points achieved with very flexible prepayment terms on the floating rate accommodating a greater range of near-term capital options.
Lenders view markets throughout the Western U.S. favorably, particularly growth markets such as Phoenix, Denver, Las Vegas, Salt Lake City, and all along the west coast. Lenders are keeping a watchful eye on urban centers, particularly those that have seen thousands of people who have relocated during the pandemic. Markets such as Los Angeles, San Francisco and Seattle remain vibrant with plenty of lender interest notwithstanding some outmigration.
As the record-high financing activity suggests, there is still capital available for a variety of property types and locations. As the industry exhibited in 2020 and 2021, it is very capable of assessing each asset on its individual merits. It is true that retail, office, and hospitality in are harder to get done. But assets with a great location, strong sponsor, with demonstrable supply and demand elements can find attractive capital notwithstanding. It may require your full-service capital advisor to look harder and to comb through the life companies, banks, credit unions, CMBS lenders, agencies, and debt funds. If the deal makes sense, they should be able to find the right solution.
For example, Northmarq was recently engaged by a long-term client to find permanent debt options to refinance two office buildings in the San Diego area. The buildings were leased to about 80%, with some short-term rollover risk and low occupancies related to COVID restrictions. Northmarq took the deal to 36 lenders with most saying no pretty quickly. But, with hard work on the phones, we were able to tell the asset and sponsor story well enough to find three very good quotes. The combination of a good asset, sponsor, and a hard-working mortgage banker found the outliers and a competitive capital solution.
So, what surprises are ahead for 2022? More of the same with several potential headwinds. The biggest uncertainty is interest rates. The 10-year treasury has already moved up 40 bps from its recent low. With actual inflation occurring, the Federal Reserve has indicated that it will raise short term interest rates during 2022.
Borrowers have enjoyed artificially low interest rates over the past few, which has fueled transaction activity and cap rate compression. In many cases, borrowers have been securing rates in the 2.25 -3.50% range as compared to 3.75-4.50% that has been more the norm in recent history. The question is how much of an increase the real estate market can absorb before it slows down transaction activity.
Another headwind is the potential changes to tax law. President Biden’s Build Back Better plan included a proposal to eliminate or cap 1031 Exchanges and substantially increase capital gains taxes as a way to help finance the plan. Both would be significant hits to commercial real estate. For now, BBB isn’t politically viable. But, with only one to two US. Senate votes, things could change very quickly.
Considering what the country has endured over the past two years, and the uncertainties ahead, it is amazing that the commercial real estate market has shown such strength through it all. Despite the potential challenges, capital markets will once again prove to be incredibly resilient. Capital sources across the board have abundant capital to lend. That capacity coupled with forecasts for steady economic growth postures 2022 to be another robust year of lending.