Are you numb yet? Continuing inflation, continuous raising of interest rates, threats or recognition of a recession!
Incoming data indicate a slowing yet resilient economy. Consumers still have in excess of a trillion dollars in excess savings, and they’re draining it, along with increasing credit card purchases to maintain a life style. Look for good numbers for Holiday shopping, especially if the mid-term elections less than a month away are seen as supportive for the economy. We find it interesting that some economists are still forecasting a recession starting the beginning of next year. By definition, we crossed that Rubicon about 4 months ago – 2 consecutive quarters of declining GDP. But apparently not declining fast enough for the Fed to cut some slack in interest rate increases.
The continued resiliency of the U.S. economy and the FOMC’s apparent willingness to do “whatever it takes” to rein in inflation has led to wide revisions in the forecast for the federal funds rate. Popular end-of-year targets range for the fed funds rate to hit 4.75%-5.00%. If so, that will give us an 8% Prime rate. If your CRE loan is priced at a base-plus rate, you’ll be seeing offers of 9-11%. Do you think this might slow CRE transactions?
So far, the CRE lending market hasn’t been that overtly aggressive. Lenders are making it up in terms, not outright rate increases that pop off the page of your term sheet or letter of intent.
The effect of increased interest rates and raising the bar on terms, however, is to disqualify loans that penciled fine only a couple months ago. We’re hearing “it doesn’t cash flow”, or “there isn’t sufficient debt service coverage”.
What’s the current disconnect in the markets? Interest rates have gone up so fast that the markets haven’t had time to adjust. Lenders can’t price their loans up point-for-point so they compensate, or make it up, in terms. Lenders and investors are scrambling to structure price and terms to continue to be viable in the market – they’re lagging. Cap rates that typically track interest rate movements are lagging also, meaning CRE prices haven’t meaningfully come down. Landlords are hesitant to raise rents as rapidly as need be to track costs (inflation of operating costs and variable rates of existing loans) for fear of putting their tenants out of business!
So, what’s the solution?
A couple obvious ones: the buyer/investor puts in more equity, thus reducing the amount of the loan, or possibly, the seller/landlord amends the lease to increase the rent payment, thus increasing the NOI and the amount available for debt service. Or perhaps the seller carries a 2nd on the property with an accrual of the monthly payments for a period of time seen as sufficient to stabilize the property, season the loan, and (hopefully) see a decline in interest rates. Or some combination of these.
Yes, it has become more challenging to do deals. But why might a buyer/borrower or seller be motivated to work so hard to do a deal that only a few months ago was seen as a cakewalk?
In the dynamic (chaotic) environment we have today everyone has their own crystal ball. How bad, how long, how good, how soon? Of course, we don’t know … BUT, popular (consensus) thinking calls for interest rates to max out in Q1-Q2 2023, but remain at the then-elevated level for a “period of time” needed for inflation to slide back into the sub-3 levels. Might it take longer? It might! Might it take less time? It might!
But the seller’s market of only a few months ago has flipped to a buyer’s market today – if only inventory would show up!
Given this planning horizon, it would suggest the type of loan to be used for the foreseeable future would be a variable rate loan, or at least an adjustable rate with short adjustment periods. Locking up a fixed rate for an intermediate to long term would seem to be punishing after the first year or 2.
Yes, a challenging time indeed. If you’re considering financing or re-financing and feel like you might benefit from a counselor, give us a call. We haven’t raised our fee for incoming calls or counseling … still zero!
Performance-based brokerage! What a concept. We work for you, not for the lender.
Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.