Commercial real estate lending is starting to see more signs of life as more sponsors are looking at and executing short-term, interest-only bridge loans.
Ed Fernandez, president and chief executive of 1031 Crowdfunding, said the Irvine, California-based firm has been seeing an anecdotal rise in these financings as borrowers work to move ahead with transactions.
“We are seeing a lot of three-year bridge lending with interest-only payments, not paying down the mortgage,” Fernandez told Real Estate Capital USA. “The intent is that in three years we should see interest rates getting back to where they need to be and then [a sponsor] can refinance to more of a traditional type of debt.”
Fernandez said he believes the more market players opting for 10-year loans with 25- and 30-year amortization schedules, the slower the recovery will be.
“That kind of entrepreneurship or strategy is continuing to help stimulate real estate transactions,” he said. “When we have these lending institutions coming out with these bridge-type scenarios, it helps market activity to continue.”
Since the start of the year, transaction activity has been slow with pricing declining in February alongside falling deal volume. According to February 2023 data from MSCI, there has been $26.9 billion transaction volume in the last year, which represents a 51 percent decrease in year-on-year volume. The sale of individual assets, volume was down 59 percent from a year earlier.
On top of this, lenders tightened their underwriting standards in 2022, a process that has continued into the first quarter of 2023. The MSCI report points out that The Federal Reserve’s survey of senior loan officers found that in the fourth quarter of 2022, a net 53 percent were tightening standards for commercial mortgages. This tightening of standards makes it more difficult for borrowers to achieve their investment objectives when purchasing properties. Into the first quarter of 2023, lenders tightened underwriting standards on a net basis at 58 percent for commercial and 57 percent for apartment lending.
Still, lenders have offered sponsors short-term options, including pay and accrual loans and five-year commercial mortgage-backed securities conduit loans.
Navigating a volatile market
While recent bank failures have created a further pullback in their short-term lending capacity, there has been an expected twist: lower interest rates have spurred another part of the market, for-sale residential.
It is nuanced situation, understanding the interplay between banks pulling back and a change in the metrics for individual home buyers and the resulting effect on commercial real estate, Fernandez added.
“It is important to understand what a banking institution has as far as cash on-hand,” said Fernandez. “If the bank is out there leveraged by 90-95 percent and only has five to 10 percent liquidity, obviously they are going to tighten up their lending. But banks that have 40-50 percent of liquidity and are only investing 50-60 percent in the market are going to have more dry powder.”
The firm keeps close tabs on what is going on in the housing market because of its broader impact, with Fernandez pointing to the NAHB/Wells Fargo Housing Market Index. The monthly index is based on a survey of homebuilders and targets on current sales of single-family homes.
The HMI Index was at 31 as of December 2022 and by March, it had risen by 44. Any number above 50 is a good sign for the markets because it demonstrates an increase in sales, Fernandez added.
Other metrics the firm tracks include mortgage applications, home sales, and unemployment rates. The firm also looks at the Consumer Price Index and GDP.
“If unemployment continues to drop, that is an indicator that there is still money in the market [being] spent, and if there’s money to be spent, then that’s an indicator that inflation is not being taken care of [and so] the Federal Reserve will continue to raise rates or keep them the same,” Fernandez said. “Those indices will give us a good pulse on what the current housing market is doing, but also what real estate is going to do [generally,] in terms of economic adjustment, such as a recession and the ways out of a recession.”
Looking ahead, the thinking is that the US Federal Reserve may start slowing the amount or severity of interest rate hikes.
“Then we’ll start seeing the housing market and real estate in general get back to a healthy place.”
The company is expanding its team, recently opening a new office in the Dallas-Fort Worth area. The firm is also planning to launch a private, non-traded real estate investment trust.
“We are positioning ourselves for growth,” said Fernandez. “The goal is to do $100 million tranches to the point where the strategy hits about $5 billion,” noted Fernandez. No further details on the strategy could be confirmed at this time.
Part of the firm’s expansion plans will be to bolster talent to support the REIT, he added. “Now we’re in acquisition mode when it comes to necessary talent, to be able to handle the accounting that the REIT is going to require.”