The chill settling in over the commercial real estate market may be gradual, but it is far-reaching – and it is advancing.

“Over the last several months, it has been a slower erosion in pockets of the market,” says Andrew Thornfeldt, a managing director who leads advisory firm Chatham Financial’s real estate investment banking advisory and defeasance practices. “There has not been one event that has really triggered any sort of exit of liquidity altogether, it has been just slowly going away.”

According to third quarter data from MSCI, US transaction volumes through the end of September totaled about $172 billion, which represents a 21 percent year-on-year decline on the same period. The report draws a direct line to the substantially higher cost of capital seen over recent months and the decline in transaction activity, noting the yield on a 10-year fixed-rate mortgage rose from 3.5 percent in late September 2021 to 5.4 percent at the end of the third quarter of 2022. “The direct impact has been a slowdown in transaction volume as the market recalibrates and people think about a different and a higher cost of capital,” says Jeff Fine, global head of real estate client solutions and product strategy within Goldman Sachs Asset Management.

For the better part of the last decade, Fine says real estate owners were able to finance assets with plentiful, inexpensive leverage. “In previous cycles, real estate participants were able to generate very high current cash returns in an environment in which revenues were largely going up and cap rates were largely going down,” he explains.

Today’s environment has changed. Fine says it is now marred by inflation coupled with supply-chain struggles, geopolitical conflicts in Eastern Europe and their coinciding effect on energy prices and excess stimulus previously put into the market.

“The decision by central banks to tighten financial conditions has led to a rapid rise in interest rates the likes of which we have not seen in modern times. This has caused investors to pull back, as most sellers haven’t yet capitulated to the market’s new reality,” he says.

Inflection point

While the Fed began its series of rate hikes in March, additional increases over the summer provided an inflection point for the slowdown in lending, Thornfeldt says. He explains some banks – bulge bracket organizations in particular – have struggled to continue deploying capital in ways that meet their lending goals. Debt capital is available, but it is situation- and sponsor-specific about moving.

“Banks are really sticking to their platinum sponsors, and typically the platinum sponsors with multiple lines of business with the bank,” Thornfeldt says, noting how the higher-graded target audience can generate fees for multiple teams within a given bank. “That does not mean deals are not getting done. But terms are certainly more challenging, particularly on large transactions.”

Broker CBRE’s most recent Lending Momentum Index shows the overall drop in lending volume of 11.1 percent from the second quarter of 2022 to the end of the third quarter this year. The November 8 data shows CBRE-originated commercial loan closings in the US also declined by 4.7 percent from the third quarter of 2021.

As traditional lenders have pulled back, market watchers anticipate a rise in activity from debt funds and other alternative lenders. This uptick is yet to materialize, in part because of a gap between lender and borrower pricing expectations. But a larger factor has been banks tightening the terms around the warehouse lending relationships through which they provide financing to debt funds and other alternative lenders. Their reluctance to provide credit lines – which had been relied upon by non-bank lenders to finance their activities – is creating a headwind for the market, Thornfeldt adds.

“It has been harder for the debt fund folks to really make their business model work if they rely on that leverage,” Thornfeldt says, with the caveat that not every debt fund requires a credit line from a bank.

“It has certainly drained a bit of liquidity and has prevented some of the non-bank lenders from really being able to step up and fill that entire funding gap,” he says.

Mezz in place

Current mortgage rates and potential refinancings layer in another degree of challenge for an already-stressed commercial real estate lending environment. Present funding gaps require creative solutions, including tacking on more subordinate debt such as mezzanine and preferred equity components. Thornfeldt says the need for such subordinate debt is visible, though carries its own issues. “Borrowers do not want double digit ‘pref equity.’ They do not want the type of clause that folks are willing to put out,” he says.

“There is concern about the potential for strife as it relates to refinancing existing commercial and multifamily mortgages,” says Lisa Pendergast, executive director at trade association Commercial Real Estate Finance Council. The higher rates available at present and potential diminution in cashflow in place on any given property signal difficulties in garnering and securing refinance capital.

The CMBS market has its own challenges, with the sector facing a $52 billion wall of near-term maturities of loans with debt service coverage ratios of 1.25 or less in the next 24 months, according a report released in November from New York-based data and analytics provider Trepp.

Alan Todd, head of CMBS strategy at Bank of America, says loans coming due now that were issued five to seven years ago now in CMBS are having to refinance their entire amount at what could be potentially higher rates. “We had 10 years of cash-out refi. It is reasonable to assume that we are going to wind up in a cycle where there is a significant amount of need to infuse additional equity to make a property refinance,” Todd says.

Missing the target

Pendergast shares a concern with many commercial real estate debt market participants of an overshoot in the raising of interest rates by the Federal Reserve if more 75 basis-point increases are initiated following November’s hike. From March onward, the central bank openly telegraphed its intent to taper inflation through continued rate hikes and, so far, has totaled a 375 basis-point increase in the Federal Funds Rate up to November 2.

Troy Marek, managing director and group head of real estate capital markets project finance at Regions Bank, says the Federal Reserve’s actions have led to a second half in which banks have been more selective with when and how they are financing new debt deals.

“In the first half of the year, we saw banks, life companies and debt funds all active. We had everybody out there – and as we got toward the second half of the year there were still obviously strong fundamentals, specifically within the multifamily space,” Marek says, noting the second half told a different story.

Atop the potentially persistent high inflation, Pendergast notes the US gross domestic product growth could continue to be negative. In the second quarter, GDP dropped by 0.6 percent before rising again in the third quarter to 2.6 percent. She says asset pricing may continue to be elevated and should properties suffer further hits to cashflow, valuations from a cap rate perspective could decline.

“The first and most significant unknown is how far does [the Fed] push? And the second is how resilient are some of those tenants and property owners?” Pendergast asks. “Normally, you would buy hard assets in an inflationary environment. But this is different.”

Marek says the market is delving into unknown territory with the 75-basis points hike announced on November 2 and subsequent interest rate hikes expected with amounts not yet clear. “The overall market will be a little bit smaller next year than this year,” Marek says. That thesis was confirmed November 10, with the The Federal Housing Finance Agency reducing the multifamily loan purchase caps for Fannie Mae and Freddie Mac to $75 billion each compared to the $78 billion they were allotted in 2021.”

Capital ready

Despite the pullback in lending activity, many real estate executives still see a solid base of institutional and other capital ready to be opportunistic. For global investment managers and large investors, including pension funds and sovereign wealth funds, Thornfeldt says their top focus is geared toward understanding the risks in their current portfolio as they relate to assets and leverage profiles so they can be more confident in their liquidity as opportunities to deploy capital materialize.

“I have not been hearing a lot of lenders digging for ideas on ‘how do we get creative to deploy capital and win’ in this environment,” Thornfeldt says.

Underwriting today

Debt transactions between $25 million to $50 million have proven to be competitive in the current market, especially with non-bulge banks competing aggressively, according to Andrew Thornfeldt, managing director at Chatham Financial

Troy Marek, managing director and group head of real estate capital markets project finance at Regions Bank, says the Birmingham, Alabama-based bank has seen a return to basic indicators when it comes to sourcing and securing new commercial real estate debt business in today’s market.

“We are looking at continued job growth, migration trends, population trends and the strength of sponsors associated with the deal,” Marek says, noting his firm and its peers are asking sponsors for more equity upfront because of higher rates. Thornfeldt adds: “Now, at the end of the day, lenders are always benchmarking terms and pricing in a competitive landscape so that inevitably has led to tighter underwriting, continued modest spread expansion and people just being a little bit pickier on their deals as time has gone on.”

Instead, time otherwise spent on debt transactions is going toward understanding debt covenants, refinancing risk, the probability of guarantees getting called and getting arms around liquidity in today’s environment and on a quarter-by-quarter basis over the next four to eight quarters.

Equity sponsors in particular have done well over the last several years, and Thornfeldt says they are sitting on cash reserves. “They are going to really pick their spots in terms of when they are willing to take on expensive mezz or preferred equity capital that may not align with their original business plan,” he says, noting they are likely to wait and see if some of the 2022 year-end volatility calms down before returning to invest again.

“The significant difference today is that we are unlikely to see the same level of distress that we saw in the global financial crisis,” Pendergast says. “The level of distress will be less because the underwriting and leverage points on these loans are significantly more conservative. To the good, there is capital out there posed to be put to work in distressed situations that will put a floor on potential losses and allow for a quicker recovery.”

The saving grace, in Pendergast’s view, is how the industry went into the ongoing market crisis with lower loan-to-values, less leverage and more interest coverage on those loans.


Absent a wave of opportunistic lending activity from either traditional or alternative sources, the next shape the commercial real estate debt market takes is seemingly being chalked up to how the Federal Reserve continues or tapers its interest rate hike program, according to industry executives and watchers.

While multifamily debt opportunities remain in vogue as rent growth in the sector holds steady, there is still little clarity to be had when assessing what types and sizes of deals will bring the biggest names in traditional lending back into the market at the similar volumes recorded in recent quarters.

Goldman’s Fine says there has been a growing appreciation for the need to maintain liquidity in real estate markets.

“The lack of liquidity when financial flows really slow down is the enemy of maintaining healthy markets,” Fine notes. “Fortunately, alternative capital has stepped in so that we do not have a one-dimensional capital market solely reliant on bank lending. Hopefully equity sponsors also learned something from the financial crisis and from the pandemic where maintaining adequate liquidity reserves in order to fund through volatile periods proved to be really important.”

The magnitude of this price resetting is ultimately going to be disruptive with the cost of capital rising so much. “Hopefully, there are still levers to pull and liquidity to access to be able to get through to the other side,” Fine says.