The Federal Open Markets Committee's recent move to raise short-term interest rates has commercial real estate debt and equity financing markets even more upbeat about their prospects in 2016.
Commercial mortgage debt outstanding is at its highest level in six years, and interest rates remain historically low. And while commercial mortgage rates aren't directly tied to the Federal Funds Rate, the 25-basis-point increase in December should encourage lenders to make more funds available for commercial mortgages and other types of loans. Plus, the Fed's move suggests growing optimism about the condition of the economy, which should in turn boost lender confidence.
That should continue to hold true, even as the FOMC is expected to push rates up four more times in 2016, said Shlomi Ronen, managing principal of nondepository merchant banker Dekel Capital. The FOMC is "giving us some notice that is what they want to do. So as long as they follow the script they've laid out, I think investors and developers are going to take the increase into consideration [but] continue doing deals," he said.
Competition will also help to keep rates low, said Rich Walter, senior managing director of Promontory Interfinancial Network. This is not just between banks and other banks, but other debt sources too, including securitizers and life insurance companies, as well as Fannie Mae and Freddie Mac in multifamily deals.
Even credit unions will be more active in the CRE market, said Pam Easley, the chief executive of Extensia Financial. The credit union service organization facilitates CRE transactions by bringing together lenders to finance commercial mortgages that typically range between $200,000 and about $20 million, she said.
"We're actually seeing a resurgence of small business lending within the credit union industry because after the recession, credit guidelines and understanding the borrower has gotten to be the thing all institutions know a lot about now…so there's a lot more control," she said. "And what we're seeing in the credit union industry is actually increased demand, not only from the borrowers but also from the credit unions who want to extend out the credit. But they do it in a manner that is safe and sound in working with the borrower and explaining why a certain credit will get considered over another."
There will be a pause in finance activity as both property buyers and sellers digest the implications of the FOMC action, then it will be back to business as usual, said Ernie Katai, executive vice president and head of production at commercial real estate lender Berkadia. Buyers will take time to recalculate a property's return on investment while lenders will look into making sure with higher rates the borrower has enough funds for the debt service coverage.
As rates go up, "sometimes more creativity and hard work come into play because you've got to figure a different way to [make the transaction work]; you may have to look at the capital stack different than you have been in the past," Katai said. "At a quarter-point that probably isn't significant, but if we continue to see a trend, that will become important."
If the FOMC raises short-term rates another 25 basis points in the first quarter, "this conversation gets a lot more interesting and people will watch closely. I don't think at this point people are nervous about another increase right away for a couple of reasons: inflation seems to be staying in check and oil prices are down," he said.
"While there's been a decent recovery, there hasn't been a gangbuster, crazy, economic recovery that would make you think that we're going to keep seeing a whole series of these increases," Katai added.
Funding is available for both debt and equity transactions across most commercial property types, though one area that might lag is multifamily, which has experienced years of heightened activity amid growing consumer demand for rental housing. There is a concern among investors about the low return on their investment as well as whether rents can continue to grow at the pace they have, noted Walter.
Ronen added that on multifamily loans, "Yields are getting compressed to a point where, especially in primary markets, the risk-return profile of those deals probably doesn't make any more sense to a lot of investors."
"A lot of investors on the equity side already have pretty significant exposure to multifamily. So they're looking to diversify their funds and get exposure to other product types," he said.