Borrowers can expect to see continued strong liquidity for commercial and multifamily properties in 2019 as lenders across the capital spectrum look to invest more dollars than they did in 2018. The market volatility at the end of 2018 that created pricing uncertainty and hesitation has dissipated, and the relative stability in the indexes, including the 10-year Treasury, should translate into a relatively smooth runway for lenders to increase their deal flow this year.
Many lenders are making adjustments to more aggressively pursue deals. The tactics vary, but include lowering spreads or going further up the capital stack with structures that should result in more accretive debt on initial acquisition yields.
It is no surprise that multifamily and industrial remain the favored property types, while retail transactions are more challenging. A notable shift for the coming year is increased interest in and capital availability for office transactions.
Capital Stack Trends to Watch
Investors/borrowers continue to lock in long-term, fixed-rate money due to spread compression and a flat yield curve. Competition will remain heated for value-add deals, and financing will be bolstered by abundant capital still flowing to debt funds. Borrowers navigating in that increasingly crowded space will benefit from knowing who the active debt sources are and understanding the real-time differences in what those individual players have to offer.
Acquisition leverage on senior debt has often been debt coverage constrained recently, so borrowers can expect to see more structured transactions ahead. In some cases, mezzanine debt and preferred equity are being used in combination with first mortgage loans. While this can be complicated, it can allow borrowers to obtain financing up to 90 percent.
Another option is short-term debt through debt funds or life companies where the loan is sized off of interest-only debt service coverage. This allows for more aggressive loans on the front end. In these situations, the lenders are looking for value creation through management expertise and capital investment to drive rents higher and increase value so they can exit the interim financing in three to five years.
Insights on Capital Sources
- GSEs: 2018 was a record year of loan originations for Freddie Mac, and Fannie Mae’s year-end number was close to the record set in 2017. This year will likely be on par related to overall volume for both entities. There are no big product changes in the pipeline, but GSEs are expected to aggressively pursue new business with lower spreads, more I/O and more flexibility built into loans.
- Life Insurance Companies: Lenders will continue to be active with a majority of capital focused on disciplined lending. Some life companies have carved out separate programs or allocations to higher risk loan products, such as construction or bridge loans, on a limited basis. Many life companies are also attracting third-party capital for investment from their peers and smaller life companies that don’t have investment staffing.
- Debt Funds: Increased competition is forcing debt funds to get more creative. Although funds might have found a floor on pricing, they are likely to stretch on placing dollars, such as doing deeper value-adds, more construction loans, or preferred equity.
- CMBS: CMBS continues to serve its core target market, such as higher leverage retail and hotels. More broadly, borrowers are nervous about the ability of CMBS lenders to execute. At the end of 2018, the jump in the 10-year stalled transactions from some shops that couldn’t quote a deal, which left some borrowers in limbo on transactions.
- Banks: Banks have good liquidity and a strong appetite for commercial/multifamily loans; however, they are also cautious about their concentration in a particular submarket or property type.