As we reach the mid-point of 2019 and as the commercial real estate industry continues to debate where we are in the current market cycle, an abundance of available capital has created a market in which seemingly everything is financeable.
Continued capital growth in the debt fund space—in both the amount of capital raised and the number of participants—has broadened lending criteria and increased competition, translating into more aggressive terms for a wider range of business plans. The amount of capital that debt funds are able to raise with seemingly relative ease is continuing to put pressure on origination teams to deploy the capital.
From a leverage perspective, we are seeing senior loans topping out in the 65 to 75 percent range loan-to-cost depending on the product type and execution risk. Subordinate capital, preferred equity and mezzanine debt, has become plentiful with target yields in the high single digits to low double digits and generally going up to 80–85 percent loan-to-cost. We are seeing some investors push beyond the 80–85 percent loan-to-cost range but do so with back-end profit participation. In order to gain an edge on the competition, some lenders are offering higher loan-to-cost loans and selling off either a senior piece or a subordinate piece after the fact. While we’ve found that these “stretch senior” loans tend to have an-all in cost that is higher than combining a senior lender with a mezzanine/preferred subordinate tranche, they offer a significantly simpler closing process.
High Levels of Production for CMBS, GSEs, Too
On the CMBS side, there seems to be better pricing and more aggressive underwriting for loans offering 10 years of interest only. This is being driven by the way the credit rating agencies are underwriting cash flow and sizing at debt coverage ratios. For example, today a 10-year interest-only CMBS loan quote on an office building will be higher on loan proceeds and lower on spread than on a 10-year, 30-year amortizing quote.
Fannie and Freddie continue to be moderately aggressive depending on how much business they are able to capture throughout the year relative to their government-mandated lending volume caps.
Both have been very active of late with their forward lease up lending programs as developers/borrowers are finding that investors are not paying stabilized prices for properties in lease up and are therefore looking for a way to lock in low-interest rates that are prevalent in the market today. The forward lease-up programs allow a borrower to fully fund a long-term, fixed-rate loan at 75 percent occupancy with loan proceeds sized in anticipation of the property stabilizing at a 130 DSCR over the following 12 months.
In some cases, the assets have performed well, but lately in light of increased new multifamily supply in every major market throughout the U.S., lease-up concessions that were anticipated to burn off are being kept in and, therefore, the properties are not hitting stabilized NOI’s. In the current market, it doesn’t appear that the agencies are getting compensated for the risk they are taking by lending out money at sub 4 percent rates and taking on lease-up risk associated with these loans.
The Fed’s recent shift in rate policy has generated a renewed confidence in the continuing growth of the economy. However, the possibility of interest rate cuts and cheaper capital will create the potential of even more aggressive underwriting as lenders compete to win deals. Stay tuned…the second half of 2019 is shaping up to be an exciting time.
Shlomi Ronen is managing principal & founder of Dekel Capital.