Los Angeles – May 31, 2018 -Interest rates for commercial mortgage debt have increased over the past two years given the 1.00% rise in the 10-year treasury over that time period. But, that’s not the whole story. The spread over treasuries for new loans has compressed, the average loan constant has decreased, and the debt level per dollar of NOI has also increased (lower debt yields). Assuming a 65% LTV 10-year loan, increases in overall interest rates range from .20%-.60% depending upon the capital source. CorAmerica’s matrix spread has declined by .40% with a net increase in overall rate of .60%. Agency spreads for the same term and LTV have declined .54% with a net change in overall rate of .44%. CMBS spreads have declined by approximately 1.00% while the 10-year swap rate has increased by 1.19%, resulting in an .19% increase to the overall cost of capital for CMBS transactions. Interest rates are only one piece of the puzzle as there are elements to each capital source that can be positive or negative including the amount of interest-only payments, ability to lock rate, loan structure/reserves, loan servicing, and closing process/cost. CBRE’s publication, U.S. Lending Figures, tracks key metrics including average loan constant and average debt yield. Over the last two years the average loan constant tracked by CBRE declined from 6.04% to 5.89%, in spite of the increase to interest rates. This is likely due to a higher volume of full-term interest only loans funded during that period. According to a recent Bloomberg article citing Moody’s, in the first three months of the year, more than 75 percent of loans in commercial mortgage bonds with multiple borrowers were interest-only, the highest share since late 2006. On average, a borrower can wait nearly six years before paying principal, up from 2.2 years four years ago. Almost half of the loan pools backing bonds included “full-term” interest-only debt.
The average debt yield tracked by CBRE decreased from 10.28% to 9.36% over the past two years, which is indicative of higher leverage per dollar of net operating income produced by the property. Although there has been an increase in overall rates for commercial real estate debt, the impact has been limited given the combination of more interest only loans and lower debt yields. According to a recent CBRE research report, real estate has lower leverage, despite rising global debt levels. Unlike the previous cycle, U.S. commercial real estate is not over-leveraged. This suggests that real estate may offer a defensive strategy in coming years. Real estate debt as a percentage of U.S. GDP reached a peak of 23.1% in 2009. After the great financial crisis, commercial real estate de-levered, with the ratio of commercial real estate debt to GDP falling to 19.1% in 2013. While overall asset values in the U.S. are now substantially above their previous pre-recession peak, debt accumulation has lagged. As of 2017, the ratio of commercial real estate debt to GDP (20.9%) remains more than 2.2 percentage points below its previous peak.
Most lenders are trying to increase loan production year-over-year, but supply of new lending opportunities has been limited. According to an article published by Real Capital Analytics , of the major property types, only industrial, hotel, and apartment are showing volume gains (sales) for the year-to-date versus the same period last year. In April, most of the major property types registered double-digit declines in activity and total deal volume for the month was at the lowest level since early 2013. On top of a slower investment sales market, the majority of loans currently eligible for refinance would have been originated in 2008-2010 assuming a traditional 10-year loan term. This was a relatively subdued period for commercial loan originations that followed the great financial crisis. It’s not surprising to see more lenders fighting over fewer attractive opportunities with more interest-only, higher leverage, and tighter spreads. It’s a competitive market, but we continue to focus on quality risk-adjusted opportunities.
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