Commercial and multifamily mortgage loan originations decreased 13% year-over-year in Q3-22, according to the Mortgage Bankers Association’s (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. A fall in originations for office, multifamily and retail led to the overall decrease in commercial/multifamily lending volumes.
“After a strong first half of the year, rising interest and capitalization rates began to affect deal volume during Q3,” said Jamie Woodwell, MBA’s head of commercial real estate research. “Increasing yields across investment alternatives – including the 10-Year Treasury yield more than doubling during the first nine months of the year – have shifted property financing and values, and it will take time for the market to fully absorb these changes. Volatility has been equally impactful, making the sizing of transactions extremely difficult.”
The Problem
Higher interest rates and tightened underwriting standards have created an opportunity for short-term and gap lending solutions. On the heels of yet another Fed rate hike, the commercial real estate industry is feeling the painful effects of both higher capital costs and lower loan amounts.
Borrowing costs have doubled in the past six months. And rising rates and growing certainty that Fed policy will push the country into a recession is creating dislocation in capital markets. Large banks in particular have largely moved to the sidelines on commercial real estate lending, and first mortgage lenders across the board—including Fannie Mae and Freddie Mac—are dropping loan amounts based on higher costs of debt service coverage.
Some borrowers are effectively frozen, uncertain of how to respond and how to recapitalize, while lenders also are uncertain of how to lend in a market where there is so much turbulence and uncertainty. Although there’s not much lenders can do to lower their rates, they are searching for solutions to keep capital flowing. “We have really pivoted our focus over the last nine months to try to be reflective of the new reality we’re dealing with,” says Scott Larson, managing principal at Pangea Mortgage Capital (PMC). The middle market balance sheet lender is stepping into areas of the market where capital has disappeared.
New Solutions
Floating rate transactions aren’t nearly as viable or as efficient as they were six to eight months ago. So, a lot of borrowers are transitioning to fixed-rate lenders. The opportunistic and participating bridge loan programs are more aggressive in their structure, pricing, and risk tolerance. For example, an opportunistic bridge loan may offer up to 75% loan-to-value (LTV) and up to 90% loan-to-cost (LTC), based on the stabilized value or transaction underwriting.
Participating bridge loan programs may also include an equity component in exchange for a percentage of the value creation realized in the project at sale or refinance. These programs are for projects where you are acquiring an asset that is going to be repositioned, such as renovated and re-tenanted or converted to some other use.
Capital also is lining up to fill the growing gap between the senior loan and equity piece in a sponsor’s capital stack. In some cases, LTVs have dropped from 65% to 45-50%. Lenders are lining up to provide mezzanine financing or preferred equity. Although the gap capital space is becoming increasingly crowded, capital providers also are selective in the types of deals they are willing to do. Also, the ability to come in and structure that gap capital in coordination with a first mortgage lender is where certain firms can distinguish themselves.
Gap financing is in demand across a variety of scenarios. For example, some buyers are looking to purchase properties with assumable debt at a lower rate. Finding an existing interest rate that might be at 3 ¼ % is a lot more enticing than if they were to originate a new loan and have to take on a 6% rate. “The problem is, most of these assumable loans are at a low leverage point,” he says. For example, a property that is being sold for $10 million may only have assumable debt of $5 million. Many buyers are coming in with a 25% down payment. “So, they’re turning to mezzanine financing to help them bridge the gap.
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Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.