Continued volatility in short-term Treasuries since the start of the year has meant that commercial real estate sponsors are gravitating toward five-year financings.
The short-term Treasury rate has been particularly unpredictable since March, when Silicon Valley Bank and Signature Bank failed, and Credit Suisse was acquired by UBS. Additionally, the yield curve has been inverted since March 2022, when the Federal Reserve began its program of interest rate rises to tamp down inflation.
Intraday volatility for the two-year Treasury has been as wide as 30 basis points or more, according to market participants who spoke to Real Estate Capital USA. That volatility combined with high levels for SOFR, the floating-rate interest rate that fills the place of LIBOR, means more sponsors have been gravitating toward fixed-rate loans because the pricing on floating-rate loans is too high.
“Everyone is trying to get into a five-year, fixed-rate product with as much prepayment flexibility as possible,” says Shlomi Ronen, founder and managing principal of Los Angeles-based Dekel Capital. “We have been focusing on originating five-year CMBS, balance sheet or life company loans for our borrowers.”
Felix Gutnikov, a principal of Los Angeles-based manager Thorofare Capital, notes this volatility continues to affect the ability of lenders and sponsors to get deals done.
“We are seeing a lot of starts and stops, which is difficult because we have limited time to meet our production and capital deployment goals,” Gutnikov says. “The volatility we have been seeing creates a lot of indecision because sponsors are finding it hard to understand what will happen over the long term. They are afraid of making a decision and finding out the decision is the wrong one.”
The new bridge loan
A key beneficiary of this shift has been the five-year commercial mortgage-backed securities conduit loan, says Malcolm Davies, founder of Los Angeles-based advisory WAY Capital. Davies believes these loans are emerging as a new kind of bridge loan for supply-constrained sponsors.
While these loans are structured like traditional conduit loans, there is a key difference around prepayment. “These loans have the ability to prepay within a 12-month window, rather than a six-month window, which means you have a four-year permanent loan that could act like a bridge loan,” Davies says.
So far, there have been two securitizations of five-year conduit loans, most recently Morgan Stanley, Wells Fargo, JPMorgan Chase and Bank of America’s $675 million BANK2 2023-5Y2.
Keyvan Ghaytanchi, chief investment officer for Port Washington, New York-based manager BEB Capital, says the market needs longer periods of stability for there to be real transaction activity.
“When you compare the two-year to the 10-year Treasury and then look at the inverted yield curve, you are seeing signals that are pointing to a recession,” Ghaytanchi says. “The question then becomes where cap rates will be in three to five years. If you believe those forward curves are accurate, then you can model out a higher cap rate today and a lower cap rate over your investment timeframe.”
Ghaytanchi believes the market will start to see more stability. “Maybe some of that is wishful thinking, but I think we will start to see less frequent and less extreme increases in interest rates,” he says. “I don’t think we will see a rate decline anytime soon, but once the Federal Reserve signals it is done with its campaign, spreads will tighten. That, in effect, will lower rates and inject liquidity back into the market.”