Interest rate hikes could present opportunities for innovative lenders

Despite concerns over rising interest rates, there is a strong sense in the market that these challenges can lead to opportunity and, more importantly, innovation.

For seasoned commercial real estate professionals, there is a sense of inevitability about what comes next. At best, commercial real estate is looking at an economic downturn spurred by higher inflation and rising rates. And at worst, there is the potential for a more severe recession that delays a broader economic and commercial real estate recovery.

Lenders and borrowers who spoke with Real Estate Capital USA over the past few weeks have highlighted their concerns over rising interest rates, fueled in part by the Federal Reserve’s move to increase the federal funds rate by 75 basis points in June and opening the door to a similar rate hike in July.

But there is also a strong sense that the market’s current challenges can lead to opportunity and, more importantly, innovation.

“When I started my company in 2009 [during the global financial crisis], it was a good time because in adversity there is opportunity,” says Tammy Jones, co-founder and chief executive of New York-based manager Basis Investment Group (see related story, p. 12). “It’s different now, and a little bit more difficult, but I believe we are back at that place, and that there are opportunities.”

Regional parallels

The concerns being seen in the US are not in a vacuum, with domestic and international managers raising the same issues. These managers are also citing clear differences between the current market dislocation and what happened during the global financial crisis.

“Increasing financing costs and inflation are the main and immediate drivers of uncertainty among investors and lenders,” says Riccardo Serrini, CEO of Milan-based Prelios Group. “One clear difference between today and what has happened in the past is the liquidity, the quicker reaction of central banks, and the government [programs] that especially during the pandemic helped the mindset. Quick reaction is key to be able to face downturns.”

Riccardo Serrini of Prelios Group

“Increasing financing costs and inflation are the main and immediate drivers of uncertainty among investors and lenders”

Riccardo Serrini
Prelios Group

Prelios, like many of its peers in the US and Europe, is anticipating a steep rise in non-performing loans but is also preparing for an increase in a newer kind of distressed debt – unlikely-to-pay loans.

“The role of UTPs today warrants particular attention,” Serrini says. “UTPs are indeed a completely different play than traditional NPLs management, and only operators with adequate expertise and advanced technological know-how stand to benefit from the deep ongoing transformation of the Italian distressed market.”

The ability to handle an influx of these loans is based on developing integrated and scalable platforms. And there are broader applications of this process to the US market. “Technology, digitalization, data management, coupled with early intervention in company crisis are key elements for facing the next NPE wave. We are expecting €90 billion of new NPE inflows in the banking system in the next three years, mainly coming from SMEs belonging to the sectors most affected by the crisis,” Serrini notes.

Data sets

Understanding how an asset fits into a broader portfolio and how it is performing in real time is also important to being able to underwrite loans effectively. This is especially important in fast-moving sectors like multifamily.

“The asset class has proven to be pretty recession-proof,” says Jacqueline Meagher, a director of capital markets at JLL in Boston. “One thing that is interesting about the sector is that you’re constantly changing the tenant base – you get to re-set rents and the asset on an annual basis. They’ll be more aggressive going in, even if it means negative leverage, because they can get to those leases quickly.”

Felix Gutinov, head of originations at Thorofare Capital, believes there is a light at the end of the tunnel.

“Although there are unavoidable inflationary pressures on many development projects across the country, a significant amount of construction debt and equity financings are still closing in desirable markets that demonstrate resiliency,” he says.