New MSCI report tracks trend toward lower leverage

A new report from MSCI found that the number of loans originated with a loan-to-value ratio of 80 percent or more dropped to 11.9 percent of all originations during the first half of 2022, a decrease from 16.6 percent during the same period in 2021.

This change was one of the key takeaways in the New York-based data and analytics provider’s most recent report on the US lending market, published this week. The report also highlighted larger loan sizes and cap rates which are remaining steady despite spiking mortgage rates.

Lower leverage, higher cap rates

In addition to a decline in the number of highly leveraged loans, MSCI also tracked a slight drop in leverage through the first half of the year.

The report found average LTVs of 57 percent for first mortgages on commercial loans for the three months ending in July, with average LTV of 58 percent for apartment properties during the same period. These figures stood at 58 percent for commercial loans and 63 percent for apartment loans across the first three months of 2022, just as interest rates began spiking.

Meanwhile, the report also found that despite rising interest rates, cap rates have been remarkably steady throughout 2022. For some sectors and deals, this combination can lead to a negative leverage situation where cap rates are lower than mortgage rates. (Read our in-depth coverage on this topic in our next issue.)

But MSCI also cautioned that this disconnect around what is a key issue for market participants is unlikely to persist.

“Our main concern is [around] cap rates,” said Stephen Stein, managing partner at Los Angeles-based real estate advisory firm Tauro Capital Advisors, who was not involved in the report. “Sellers’ expectations haven’t caught up [with the changes in the market]. But you always begin optimism with caution on the lending side now because the financial markets are unstable. [Loans] are requiring rate caps and basically insurance on where the interest rate goes.”

Cap rates may not come down, says Joe Iacono, CEO and managing partner at New York-based manager Crescit Capital Strategies. “But the risk premium component of the cap rate may come down, which effectively means equity returns come down,” he added.

Larger loans, higher pricing

The average loan size crept up across all lender groups apart from CMBS loans in the first half of the year. CMBS originators moved against this trend with loan sizes that were flat to declining, with the report positing that these lenders are more in tune with the high frequency movements in the credit markets. This lender group saw the sharpest declines in LTVs at origination, as well as the sharpest increase in cap rates.

In comparison, life company lenders, which typically compete with CMBS originators for larger deals, originated larger loans on average and at higher cap rates in 2022.

Additionally, pricing climbs the agenda for real estate debt market participants.

“How that pricing may play out is uncertain,” reads the report. “But if mortgage rates remain where they are, cap rates would need to adjust upward by 140 basis points for commercial properties and 150 basis points for apartments to bring cap rates back to the spreads that dominated from 2012 to 2019. Investors could, of course, use more equity for deals and target lower returns.”

The other way out of the lower liquidity situation would be if some group of lenders took a contrarian view and pushed more capital to the market, suggests MSCI.

Most lenders are tightening standards with lower LTVs than in recent years, however. Only the insurance companies and investor-driven lenders swim against this current. Insurance company lenders originated loans at higher LTVs so far in 2022, but typically these are for loans with longer terms than these lenders did in the recent past.

The motivations of the investor-driven lenders are always different from those of traditional lenders who do not want to end up with a property in foreclosure.