Interest rates, the most important factor in commercial real estate transactions, are expected to be higher for longer – and borrowers are starting to accept what is expected to become the new normal, according to panelists at a Chatham Financial webinar held on Thursday.
Commercial real estate borrowers and borrowers in other asset classes are starting to move ahead within this new reality, said Jackie Bowie, managing partner and board member head of EMEA at Chatham Financial.
“This time last year, [clients] might be looking at a one or two–year extension if they had that opportunity, but now it feels like we’re getting closer to the point where there’s an acceptance of higher rates for longer, and perhaps there will then be a bigger tranche of people coming out for more wholesale refinancing,” Bowie said.
A key component of the webinar was analysis of the macroeconomic picture in the US and further afield and the impact that higher rates are having on the global economy and transaction volume across markets and sectors.
Amol Dhargalkar, managing partner and chairman for Chatham’s board of directors, noted that inflation declined from more than 8 percent in July 2022 to less than 4 percent one year later because of the Federal Reserve’s actions. But progress is not always linear, he cautioned.
“We’re not quite on this one-way journey down back to where we were in a pre-inflationary [market],” Dhargalkar added, citing metrics which include a recent increase in energy prices and an uptick in inflation.
Navigating today’s market
More borrowers are opting for short-term bridge loans which they believe will allow them to buy time to execute a business plan or simply wait until rates are lower than they are today. As banks have scaled back their commercial real estate lending over the past year, more borrowers are turning to alternative sources of capital, panelists said.
“The private source of capital and lending has been around for a long time, but what we’ve seen in the last year in particular, is a combination of seeing them present in many more transactions than we used to, and certainly seeing more announcements of capital being raised – large alternative asset sponsors would raise capital from the global sources for their strategy,” Bowie said.
Bowie added that the market also started to see some banks joining forces with alternative asset managers and financial sponsors to raise capital within the private debt arena.
“We’re finding that borrowers are having to learn new ways to navigate the markets to try and understand how to best tap into this private debt market and how the structures work because it’s very different [from] what they’ve seen from their traditional relationship bank,” Bowie said, adding that the transparency of interest rate cap pricing is a core issue when cooperating with private debt funds.
On the ground
Market participants who have spoken with Real Estate Capital USA over the past week are seeing a similar story play out among fund managers, borrowers and lenders.
Scott Helberg, a senior tax adviser at consultancy RSM who was not involved in the webinar, said the New York-based firm is seeing innovation in the way in which capital is raised and deployed.
“We’re seeing our clients be more creative in how they invest in real estate. While they may have historically been investing in office and apartments and industrial, they’re looking at preferred equity, they’re also looking at perhaps non-traditional assets, whether that’s data centers, or maybe they’re starting to get into senior living or other things like that,” Helberg said.
He continued: “Consistency and predictability are such core aspects of real estate, so being able to trust that interest rates aren’t going to fluctuate nonstop over now, I think you’ll start to see the gap shrink between the bid and ask prices on assets,” he said.
Forward curve analysis
Panelists on the webinar took a hard look at the impact of interest rates on Treasuries and SOFR, the key fixed- and floating-rate benchmarks for commercial real estate transactions.
The three-month term SOFR forward curve, which is often used as a baseline prediction for future interest rates, is rising. This is an indicator rates could stay higher for longer, panelists said.
The five-year SOFR swap rates, a benchmark which allows market participants to hedge interest rate volatility, rose from close to 0.5 percent in June 2021 to above 4 percent this year as well, according to Chatham Financial.
“That rapid rise is something that many folks have not experienced and it had a meaningful impact on the banking system and different strategies that our clients have been using to navigate through this market environment,” Dhargalkar added.
Following the Federal Reserve’s September meeting, the two-year Treasury yield reached the highest point since 2006 and closed at 5.12 percent last Wednesday.
According to Chatham Financial’s data, the US two-year Treasury first approached the 10-year Treasury yield in early 2022 and surpassed the 10-year Treasury in summer 2022. The curve has been inverted ever since then, an indicator considered related to recession.
The inverted yield curve shows long-term interest rates are lower than short-term interest rates, reflecting bond investors’ expectations for a decline in the longer-term return.
“I think a lot of people are very confident that there’s a recession coming, and this indicator [two-year Treasury] is excellent at telling you that a recession is coming, it’s less excellent at saying when that recession is coming though,” Dhargalkar said.
Outlook
While market participants believe the Federal Reserve is nearing the end of its current cycle of rate increases, no one knows when these increases will finally halt.
Dhargalkar said the Federal Reserve has been hinting at its intentions effectively regardless of how that signal was received by the market. “The very big question is whether the market believes the Fed or not,” he said.
He continued: “The Fed is trying to do everything in its power to indicate that they are not intending to cut rates quite as quickly and as severely as the market thinks. Prior to last meeting, Fed set projections from June that four rate cuts [are] expected in 2024, and that’s come down to two cuts expected in 2024.”
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