October 2, 2020
Activity Expected to Accelerate in Q4 As Lenders Reassess the Landscape
Recent conversations with institutions and investors across the lending landscape suggest dynamics are shifting quickly. After a strong first quarter, lending activity diminished significantly as market players paused to assess the impact of the coronavirus pandemic. As we enter the fourth quarter, we expect to see deal velocity accelerate, with a shift in priorities to reflect evolving opportunities and risks. Here are some of the recent insights we have gleaned from lenders and investors about how they are approaching the new normal.
More Asian and European institutions are looking to invest in open-end funds in the U.S. With negative interest rates in their home countries and corporate bonds at 2 percent or less, banks and insurance companies are drawn to commercial mortgage loans, where they can earn yields of 2.5 to 3 percent. Light transitional properties are a potential sweet spot, where some investors are willing to take additional risk for higher yield.
As we enter the fourth quarter, we expect to see deal velocity accelerate, with a shift in priorities to reflect evolving opportunities and risks.
Meanwhile, some investment banks see opportunities in fixed-rate construction loans as a vehicle to lock in low-leveraged deals, for example, stabilized apartments at 50% LTV coming off bank mini-perm financing. These banks are willing to take the construction risk in exchange for a yield that is 50 to 75 basis points higher than the permanent loan. Some investment banks are doing light transitional loans with a solid risk-adjusted return, while others are considering the preferred equity space.
Some multinational banks say they are working on modifying loans in their portfolios, providing payment relief and covenant kickouts on non-essential retail and hotel properties, while multifamily, office and industrial have performed better than expected. Big banks offering bridge loans, term loans and construction financing for their own balance sheets say they are focused on helping current clients with strategically important transactions in the coming months, primarily in tier one gateway markets and select secondary markets (aka “NFL franchise cities.”) Some institutions are favoring multifamily, build-to-suit industrial and some pre-leased office, while looking cautiously at vacancies, market concession rates and supply trends. As a number of institutional investors retreat from the market, high net worth and family office capital is filling the void. More private investors are entering the market for the first time, seeking safe haven from geopolitical instability and volatility in stocks and other asset classes.
As for major CMBS lenders, some say they see COVID-19 as a temporary phenomenon but are avoiding COVID-sensitive retail properties with mom and pop restaurants, movie theaters, gyms and hotel tenants. They are prioritizing logistics, self-storage and essential retail such as grocery and drug stores. Structurally, some are doing more acquisitions and less cash-out refinance, which typically requires higher leverage and reserves.
A number of credit unions are shifting their focus to multifamily, mobile home, self-storage, medical and multitenant industrial properties, as well as some single tenant industrial. They had previously favored Class B neighborhood retail and grocery-anchored centers. Though return objectives vary, the average is 4.5 percent for a standard fixed-rate loan with a five-year term and a rate reset for the second five years with no pre-pay penalty. While that’s higher than other players in the market, the profile of borrower and collateral tends to be different. LTVs are generally more conservative but top out as high as 70 percent, depending on the deal and borrower. Underwriting is focused on sustainable revenue, net income and value. Credit unions are looking carefully at guarantors’ liquidity, net worth and the rest of their real estate portfolios.
Across the board, lenders say COVID-19 has underscored the importance of relationships. In times of market turmoil, borrowers may want to prioritize working with experienced lenders who demonstrate a consistent ability to close. One CMBS lender told us that roughly 10 percent of the firm’s pipeline came from borrowers left at the altar by competitors who had won the option but overpromised and underdelivered. With the broadest network of lenders and unparalleled professional service, MMCC can find the right capital source to get to the finish line in any real estate cycle. Please reach out to an MMCC advisor for guidance.
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