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The Fed, Funds and CRE Financing

In March 2022, the Federal Reserve approved its first interest rate hike in more than three years. Since that time, much has been written about the impact of ongoing Effective Federal Fund Rate increases on commercial real estate financing.

Stephen Bittel

In the wake of the most recent EFFR increase, experts told Connect CRE that there is no doubt that continued hikes are impacting commercial real estate funding. Reliable sponsors can still obtain bank and life insurance company debt. But “nearly all of the Wall Street-type loan funds that rely on lines of credit or repurchase agreements are effectively out of new business without admitting it publicly,” said Stephen Bittel, founder and chairman of Terranova Corporation. Meanwhile, he continued, lenders are focusing on near-term renewals and stress-testing existing loans at renewal rates from 5.5% to 6.5%, “well in excess of loan rates from the last few years.”

Meanwhile, Chad Plumly said that while his company, Matthews Capital Markets, doesn’t rely on the Fed rates when it comes to financing, the hikes are impacting the overall markets. “In turn, treasury rates and term SOFR rates have increased significantly,” said Plumly, who is First Vice President with Matthews Capital Markets. Additionally, “borrowers seeking short-term floating rate or construction financing are finding it relatively more difficult than those seeking long-term financing,” said

Chad Plumly

Then there is the impact on real estate debt securitization vehicles, including collateralized debt obligations (CLOs) and commercial mortgage-backed securities (CMBS). “Investors in those securities are trying to make sense of where the market is going,” observed ACRES Capital President and CEO Mark Fogel. “At the same time, lenders are concerned about the rise in interest rates, and how they might negatively affect property values. The current environment makes it difficult to determine proper loan sizing and terms.”

Still, while the Federal Open Markets Committee’s actions are pushing yields upward on U.S. Treasuries, short-term rates have been impacted most. “This means borrowers seeking short-term floating rate or construction financing are finding it relatively more difficult than those seeking long-term financing,” said Michael Chase, Managing Director, Debt & Equity, Northmarq.

Nor is it rising rates that are the problem. “Uncertainty leads to volatility, and this impacts transaction volume by making investment decisions difficult, and driving a wedge between buyers and sellers,” Chase said. This, in turn, impacts asset valuations. “Certain types of financing will remain more challenging, until there is a decrease in market volatility,” Chase said.

Mark Fogel

Plumly agreed, saying that the market volatility causes problems for lenders when it comes to pricing credit risk. “All parties to the financing, specifically lender, borrower and mortgage broker, need to recognize the dynamics of the current rate environment, and how quickly terms and pricing can change,” he added.

Furthermore, “lots of deals simply don’t work at the new rates, causing a slowdown in transaction volume for both debt and equity,” Bittel commented. “Debt paydowns and turbo amortization will be the norm to right-size debt.”

Nor are things likely to change, short term. “In the near term, borrowers will generally find lenders using more conservative underwriting, and placing added focus on their refinance test,” Chase said. Bittel added that loans to value will decline as lenders are more cautious regarding rate hikes and potential economic slowdowns. “It will be a rocky next six months until inflation moderates, and rates start to decline,” he added.

But all isn’t necessarily gloom and doom. Chase, for one, explained that asset types like multifamily and industrial will probably remain the favorite of lenders and investors due to demand and market rent growth. Furthermore, multifamily can likely count on financing from Freddie Mac, Fannie Mae and FHA , he said.

Michael Chase

According to Fogel, other finance institutions will step up to fill in gaps left by lenders leaving the market. “With decreased competition and healthier interest rates, these lenders are seeing opportunities that they haven’t in years,” Fogel said.

Also helpful is that today’s lenders remain conservative and consistent. “This was not the case in the frothy times of 2006-2007, when LTVs were quite high, and underwriting was very aggressive,” Plumly noted. “This, in turn, caused extreme market disruption when the market imploded.”

In all, rising rates aren’t to be taken lightly. They will likely continue driving market uncertainty and require strategic shifts. Still, “regardless of current market rates, loans will continue to mature, properties will continue to be bought and sold, and for the most part, the majority of today’s lenders will still be in business and closing loans,” Plumly said.  

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Inside The Story

Terranova's Stephen BittelMatthews Capital's Chad PlumlyACRES Capital's Mark FogelNorthmarq's Michael Chase

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