The black economic cloud that is typically associated with an inverted yield curve does indeed have a silver lining.
The correlating chart shows the U.S. Treasury rates for Jan. 2, 2018, the blue normal curve, and Aug. 13, 2019, the red inverted curve. The inverted portion of the curve doesn’t turn positive vs. the 20-day bill until about year 25. As an investor, going out a full 30 years would only get you only a few bps (basis points) more than buying a 30-day T-Bill. But we’re not considering the investment side of this; we’re looking at this as borrowers.
Among all the credit markets, there tends historically to be correlations among the various types of debt instruments. The correlations are not exactly 1:1, but they maintain their linkages within fairly predictable ranges, in spite of the Feds intermediation the last decade. CRE debt operates within this atmosphere.
CRE lenders, be they banks, hedge funds, insurance companies, ESAs, etc. take their cues from their cost of money, alternative investment vehicles, creditworthiness of the borrower, geographical location, asset class, and a few other parameters. Borrowers traditionally pay a higher rate (cost of money) for the longer the term of the loan. At this time, however, longer terms have a lesser rate with the lowest rate at about 5 yrs., and longer term Treasuries don’t surpass the 30-day Bill until about the 25th yr.
If you’re considering a conventional CRE loan in the 5-10 yr. maturity range, you should expect to find tight spreads for rates, all other terms being equal (which they never are). This suggests you can borrow longer term for a nominal incremental rate. What’s the cost to renew a 5-yr. loan at the end of the primary term? … a point? Today the difference between the 5 yr. and 10 yr. is about 20 basis points. You can extend that 5 yr. loan today for a successive 5 yr. period (a 10 yr. term) for less than a ¼ of a point, and no re-application cost or hassle. Lenders will offer products up and down the maturity line as a function of the parameters mentioned above, in addition to keeping an eye on the competition.
There’s currently an excess of liquidity in the debt markets, particularly among the non-bank lenders not subject to banking regulatory rules. Late in the market cycle borrowers are cautious about taking on new debt. This creates a supply-demand imbalance in the borrower’s favor. Lenders will structure products (loans) to fit the current curve, promoting the shorter term maturities with fixed rates, and longer term offerings leaning toward variable or adjustable rates, the exception being Government guaranteed loans. Longer term fixed rate loans in this environment may be hard to come by – at what point will banks start to pull commitments because their spread goes to zero? Other terms and conditions may come into play compensate the lender for anticipated curve normalization over the term of the loan – be sure you read all the terms of the loan, not just the rate and maturity.
Be sure you consider private money sources, too. They can be more aggressive/competitive in “unusual” environments like the one we have now, and possibly will have for the next year or so (or more?).
AND NOW, YOUR ATTENTION PLEASE
You’ve heard of ZIRP – zero interest rate policy – from 2008-2015. Now get ready for NIRP – negative interest rate policy. Currently about $16 trillion of sovereign bonds (all countries that issue), or 25% of the total outstanding, trade at negative interest rates. This trend is firmly in place and increasing. The investor is paying the issuing country for the privilege of lending them money, or seen a different way, the investor has locked in a guaranteed loss if the bond is held to maturity. This is Alice in Wonderland monetary policy. Will Jay Powell turn out to be the least insane man in the asylum? And what does this mean to us in the CRE borrowing business? How might we expect this trend to color our borrowing potential going outbound?
MORE ABOUT THIS NEXT TIME. (It’s not likely to change in the next 30 days.)