New York-based Crescit Capital Strategies is originating more fixed bridge loans as wary borrowers look to mitigate the risks associated with the projected continued rise in interest rates.
Since the start of 2022, the benchmark 10-year US Treasury has risen from 1.5 percent to around 2.97 percent at the start of June. During that time, the Federal Reserve Bank has also increased the Federal Funds Rate by 75 basis points, including its first 50-basis-point hike in more than two decades.
“Nobody wants to lock in long-term debt that’s not pre-payable with a significant penalty at today’s rates,” said Joe Iacono, CEO. “And the market is asking, ‘Is this the new paradigm? Or will this too pass?’”
Because of a wariness over locking in long-term rates today, borrowers that might have gone to the commercial mortgage-backed securities market for 10-year, fixed-rate financing are looking at other alternatives in the hope that today’s rate environment is a short-term phenomenon. Hence, there’s interest in fixed-rate bridge loans, Iacono explained.
“We are now seeing assets that are stabilized that frankly could qualify for a CMBS loan,” Iacono said. “These borrowers don’t want to lock in long term and would rather come to us for a short-term loan, whether its fixed or floating.”
While the firm is getting good traction for its fixed-rate bridge loans, Iacono is a bit surprised more borrowers aren’t considering this option. “There is sticker shock over how much higher rates are,” Iacono said.
One major concern for borrowers in the cost of interest rate caps, a factor which is leading more to consider short-term fixed-rate loans.
“We’re trying to price our fixed-rate loans at a lower cost of capital than the borrower would see with a floating-rate loan and an interest rate cap,” Iacono said. “CLO shops in particular generally require borrowers to buy caps on floating-rate loans in order to get the proper rating. But the cost of caps is also changing as the markets are evolving and have been high for obvious reasons – the market anticipates rates are going up.”
Iacono estimated that on a three-year, floating-rate loan, an interest rate cap that matched the term of the loan was being priced as high as 2.5 or 3 points up front. “It’s a large expense and it’s important to remember that the borrower still has the rate risk until the interest rate cap kicks in,” Iacono said.
Floating-rate lenders are finding ways to mitigate some of these costs, including springing caps that don’t kick into gear on the first day of a loan or offering two-year rate caps on a three-year loan. “There are a lot of moving pieces to figure out,” Iacono said.
Slower transaction volume
The current environment is not without precedent, with Iacono recalling a similar period in 2005 where lenders and borrowers were grappling with these questions as rates moved upward.
“We were having a similar discussion about how rates were popping up and how it was possible that we were entering a low-growth environment and could see higher rates and stagflation. Instead of stagflation we got the Great Recession, due to other factors, and rates only went down,” Iacono said. “The overall impact for real estate is that it is slowing transactions as investors digest rates and the direction of the economy.”
While the impact hasn’t yet been seen on transaction volumes, which rose by 46 percent year-over-year in the first quarter to $150 billion, per CBRE data, the expectation is higher rates will start to challenge the market’s buoyancy.
“At a very core level, if you’re buying a property and thought you’d be able to finance it at 4 percent, you now have to finance it at 6 percent and that might lead you back to your seller to say, ‘I thought I could pay $10, but now I can only pay $8,’” Iacono said. “At that point, the seller has to digest whether he wants to accept that because he thinks his property is worth $11. This all creates paralysis to some degree. People’s expectations change minute to minute in the stock market but in real estate it takes a lot longer.”