Capital Markets, Rates, and Lending Activity 2023 Forecast
“May he live in interesting times”
Depending on your source, this is either an ancient Chinese proverb or a translation of a traditional Chinese curse. As we move into 2023, we most certainly find ourselves in the midst of such interesting times in the debt and capital markets.
In March of 2022, the Federal Reserve raised its benchmark rate by 25 basis points, to the range of 0.25%-0.50%. Since then the Federal Reserve has raised rates six more times; by 50 bps in May, 75 bps in June, July, September, and November, and then 50 bps again in December. This marks the fastest increase of funding rates in history. The purpose of the Fed raising their target fed funds rate is to increase the cost of credit throughout the economy. This will, by definition, have a direct impact on lending rates in capital markets for 2023. As of this writing, the 1-month term SOFR is at 4.43% and Prime is at 7.5%. It is expected that rates will rise another 25 or 50 basis points in February. The question on everyone’s mind now is… what comes next?
The Fed remains committed to bringing inflation back to a 2% target. With unemployment numbers showing a higher level of resilience than expected, you can widely expect that to continue. Nonfarm payroll numbers from December showed a 223k increase, lowering the unemployment rate to 3.5%, marking 2022 as one of the best years of job growth ever with 4.5 million jobs gained. Considering the dual mandate of the Fed to 1) limit inflation and 2) curb unemployment, the fact that the economy added jobs while they were aggressively raising interest rates gives them wiggle room to continue doing just that – to focus on fighting inflation. The minutes from the December FOMC meeting included a warning to investors not to underestimate their willingness to keep interest rates high for some time. Officials issued new forecasts indicating a continued hawkish sentiment, with more hikes projected in 2023, and no rate cuts this upcoming year.
What does this really mean for rates? The general consensus on rates for the first half of the year calls for another hike in February, and then rate movement to halt. This should see rates stabilizing going forward. Many lenders we talk to are keeping their spreads on 5- and 10-year treasuries to 150-200 basis points, meaning conventional bank debt will be in the high 5% to 7% range following February’s rate hike.
The era of free money for CRE is ending, but this is not all bad news. As interest rates and lending markets stabilize, there will be a necessary adjustment of cap rates and CRE price valuations… and therein lies opportunity. Investors with long-term strategy, or buyers at lower LTVs, will find themselves in a position of strength in the acquisitions market. The hallmark of the past decade was the compression of yields due to the cheap capital throughout the CRE industry. 2023 will be the year the real estate market goes back to the basics and focuses on cash flow – properties with the cash flow to cover higher interest rates, and borrowers with the capital to make purchases at lower LTVs, won’t have to chase deals. One thing I can say with complete certainty… 2023 will be an interesting time.
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