Market dislocations shifting power balance towards lenders

The trifecta of interest rate hikes, rising inflation and a potential market downturn means commercial real estate lenders have more latitude in selecting and originating new loans.

Over the past decade, historically low interest rates have contributed to a major expansion of liquidity in the commercial real estate debt markets, and also have given borrowers ample opportunity to negotiate advantageous terms with their lenders. But now, lenders are gaining the upper hand and gaining the ability to build a stronger portfolio.

“If you can call the credit right today, the loans you originated are going to have more value because there’s more call protection in those loans. There’s less of a chance that your borrower can optimize the capital stack by rates going down,” Jason Hernandez, a managing director at Nuveen, told Real Estate Capital USA.

Beyond interest rate constraints, Hernandez sees broader market disruptions as potentially beneficial to well-capitalized lenders.

“If you think there’s going to be an economic slowdown, credit is a great position to be in,” Hernandez said. “Given the volatility and inflation in the forward curve, we can do multifamily and industrial at 100 basis points wider than we could three months ago.”

The haves (and the have nots)

While Nuveen’s focus has been on burgeoning sectors like multifamily and industrial, Hernandez sees growing opportunities to lend at a premium on a more troubled sector with a few caveats. The property needs to be a high-quality asset in a promising market.

“I don’t want to take massive lease up risk in office, unless I’m in a market that’s like Austin or Raleigh, where I’ve got tremendous tailwinds and a lot of absorption,” Hernandez said.

It comes down to evaluating which chances are worth taking and which ones are to be avoided.

“If I can find a good asset that I can finance at an attractive basis with minimum distribution risk, I’ll take liquidity risk. And I’ll take the bet that in two or three years, the market is still open to refinance. What I don’t do is take asset risk, like a B asset in a market like New York’s Third Avenue sub-market that’s challenged for absorption, and then also take liquidity risk on the back end,” Hernandez added.

Ronnie Gul, principal at Los Angeles-based real estate private equity fund Mesa West Capital, is also wary of lending on less promising sectors and markets.

“There’s clearly a lot more appetite for multifamily than office. It’s not hard to see a multifamily property requiring a more optimistic loan having access to capital versus the equivalent on the office side where some may say, ‘Life’s too short’ and move on,” Gul said.

Leveraging uncertainty

Borrowers accustomed to consistently favorable terms are now contending with higher borrower costs.

While this could lead some to lock in fixed rate loans now, others may balk at locking in current rates. The dilemma favors the creditor, Hernandez noted.

“We’re starting to see borrowers look for both fixed and floating rate quotes, which you really don’t see, as they’re generally pretty different. You either like vanilla or chocolate, you don’t generally like both,” he said.

But as market conditions get even more turbulent, Hernandez likes where Nuveen is positioned: “We think it’s a really attractive time to play in real estate credit.”

Gul also sees a disruptive market as an opportunity for more seasoned lenders to shine.

“I think there’s a segment of the market that wants to be in business with the more durable players who have survived prior cycles and who will be there for the next cycle,” Gul said. “People that are long-term players want to be in business with folks who are long-term players who have depth and staying power.”