KBS Realty Advisors is tracking a greater amount of stability in the US commercial real estate lending market on the horizon, with the Newport Beach, California-based manager observing a bifurcation of liquidity for different types of office properties.
The aggressive action the Federal Reserve has taken to fight inflation levels that are at 40-year highs has resulted in volatility in the debt markets, with the impact being felt on the cost of debt and loan proceeds, said Robert Durand, executive vice president of finance.
“Loan proceeds are getting adjusted downward because lenders are increasing the underwritten interest rate for analyzing take-out loans and refinancing risk,” Durand said.
While bridge lenders, particularly in the value-add space, have seen the greatest impact because the cost of the debt they use to leverage their own positions has risen, banks and life companies have also adjusted their credit spreads.
“If they’re lucky, borrowers are looking at a 100 to 150 basis point increase for multifamily assets to upwards of two to five hundred basis points on less desirable assets from where rates were pre-volatility in early 2022 or late 2021,” Durand said, noting KBS more often works with banks and insurance company lenders. “This is a big jump which impacts levered returns and IRRs.”
Still, the market is coming to terms with these changes and shifting their strategies accordingly.
“In some product types, aggressive buyers are looking to rent growth to continue to increase NOIs and help with the investment returns,” Durand said. “I think lenders are a little skeptical about relying on that assumption so there is a disconnect between what borrowers think they should get on a loan and what lenders are maybe willing to provide.”
There is a similar disconnect between buyers and sellers. “Sellers think that a little adjustment here or there will recognize the increase in rates, but buyers are saying, ‘We need a bigger adjustment because we don’t know when and if rates will drop again,” Durand said.
The market is more stable than it was a few weeks ago, with 10-year Treasuries declining from a high of around 3.25 percent to the range of almost 3 percent, and there continues to be liquidity.
“Nothing has changed with the availability of capital. The question is just where should it be priced and allocated,” Durand said. “With return to office being slower than anticipated, office has been more challenging than multifamily and industrial. Lenders are being very cautious and the haves and have-nots buildings have become very apparent. We have found that tenants like the quality of our portfolio, which has been shown in the leasing activity we have seen throughout 2022.”
While the broader office sector has been hampered by a slower than expected return to work, there is a sense among market professionals – echoed by Durand – that this may be changing. KBS leasing activity has been solid, with Durand noting the company has been signing tenants to more traditional five- or six-year leases as well as to plug-and-play spec suites.
“In the chatter we are hearing, the conviction gets stronger about an ultimate return to office,” Durand said. “I think that chatter will only get stronger as the Fed tries to soften what has been an overheated economy in some ways and employers want to make sure they can retain talent and increase productivity.”