Capital Markets, Rates, and Lending Activity Spring Preview
“I can say with complete certainty… 2023 will be an interesting time.”
The above quote was the last line of my previous column for this publication’s Capital Markets, Rates, and Lending Activity 2023 Forecast in January. Since then, we’ve seen continued rate increases, multiple regional bank failures, a forced merger of the two large Swiss banks, and just recently a CPI report showing that the Fed’s activities – while a drag on our industry – have seemingly started working to bring down inflation. We’ve also seen a historic drop in acquisition volume, both year over year and in comparison to the previous quarter. Not to toot my own horn here but I do believe this counts as interesting!
Lenders really hate volatility. As evidenced by the Silicon Valley Bank failure, an inability to predict where the economy and rate markets are going can have dire consequences for borrowers and lenders alike. However, that should start to smooth out as inflation slows towards the Fed’s target rate and rate hikes slow or stop altogether. I believe we will see one more rate hike in May, and then the Fed will pause for the summer. I don’t possess a magic 8 ball, but I would put a likelihood of cuts in the second half of 2023 as “Outlook not so good.” However, the recent CPI numbers this week show that inflation is indeed slowing, which will help take out a lot of the potential rate volatility that lenders hate so much.
In a recent 2023 Market Pulse update from Goldman Sachs, they highlighted the issues presented by the flight of deposits from regional and smaller banks. These banks account for 50% of commercial and industrial lending activities and will start pulling back – especially on LTV/LTC levels for loan offers. They also may need to raise their deposit rates paid to customers, which will push up their cost of funding. This should eventually show up in lending rates. What this means for borrowers and owners of commercial real estate is that those same banks who originate many of our loans in this industry have a keen eye on their deposit balances, and we will see more of them require a deposit relationship with the bank as a covenant in any future loan offerings.
Finally, we need to factor in asset valuations. According to a recent Green Street report, the commercial property price index is down over 15% from this time last year. Office has obviously seen the biggest price depreciation of all asset classes, but everything except lodging/hospitality has seen double-digit annual drops in their valuation index. Taken together, what does this all mean for rates and lending activity? Borrowers today and in the upcoming few months will be met with higher capital costs, fewer willing lenders, and more conservative lending terms. Deals will require more equity and cash to the table at closing. Cap rates will continue to rise to catch up with borrowing costs. However, in this repricing, there will be opportunity for investors. More than 1 trillion (with a T) in outstanding CRE mortgage debt will come due over the next 24 months, according to a recent report by Morgan Stanley CIO Lisa Shalett. There may be blood in the water, but in the midst of chaos, there is also opportunity.
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