Archives for November 2022

As businesses grapple with the current energy crisis and prepare for it to worsen, new research from JLL (NYSE: JLL) finds that these rising energy costs are expediting the move toward more efficient buildings.

JLL’s Retrofitting Buildings to be Future-Fit research reveals that net-zero carbon (NZC) intervention measures directly impact a building’s bottom line and that failing to decarbonize leads to significant financial risk. For many buildings, meeting 2050 decarbonization targets put forward in the Paris Climate Agreement is grounded in retrofitting current spaces, which can also garner higher rents, reduce financial risk and generate higher occupancy rates and tenant satisfaction.

“Retrofitting existing buildings is the quickest and most cost-effective way to accelerate decarbonization in the built environment,” said Guy Grainger, JLL Global Head of Sustainability Services and ESG. “Whether it is lenders on real estate or occupiers of buildings, requirements are changing and real assets will become illiquid unless there is a plan to transition them.”

JLL’s research reveals that in the global north, retrofitting rates need to triple from barely 1% today to at least 3% of existing buildings per year to meet decarbonization targets. An estimated US $3 trillion will be required in the office sector alone to meet these targets. In the developing world, new commercial and residential real estate will need fresh approaches prioritizing carbon and energy efficiency to improve resilience to climate change and contribute to a more sustainable future. Addressing the knowledge gap, upskilling the workforce and scaling technology will be critical to accelerating the pace of retrofitting.

“Retrofitting does not need to be an all at once endeavor. But, reporting and disclosure is not enough – this requires intentional investment and a strategic approach,” said Grainger. “Retrofits are both more viable and responsible when considered in tandem with broader asset repositioning that responds to changing workplace dynamics and climate resilience. We have enough proof points that show we have been underestimating the return upside of intervention and underestimating the value downside of inaction.”

Retrofitting buildings to be more energy efficient will also require owners and occupiers to deepen relationships and form new business models to gain the significant value they both have when investing in sustainability. The alignment of stakeholders extends beyond just the landlord and tenant as suppliers, building operators, management teams, on-site teams, and even local governments must work together to transition to a low-carbon economy.

Source: “Retrofitting buildings essential to reduce energy costs and combat the global energy crisis“

After Q2 this year, the Mortgage Bankers Association projected a drop of 18% in commercial and multifamily lending compared to 2021. They were right.

At least, that’s what CBRE says. “The Federal Reserve’s hawkish stance to reduce inflation resulted in higher borrowing costs, more conservative underwriting and lower loan closing volume in Q3,” the organization wrote. “The CBRE Lending Momentum Index fell by 11.1% quarter-over-quarter and 4.7% year-over-year in Q3.”

Some more details: Spreads widened on 55%-to-65%-loan-to-value (LTV) fixed-rate permanent loans running from seven to 10 years in length. “seven-to 10-year,” the analysis said.

Top lenders were, of course, the agencies like Freddie Mac and Fannie Mae at $30.6 billion, down 8.4% from $33.4 billion in Q2.

Next in line were banks for the second consecutive quarter, this time originating 46.5% of the non-agency loans. That’s up from 38.1% in Q2 and double 2021’s Q3. Banks are expected to remain cautious and focused mostly on permanent loans, with some bridge and construction loans.

Alternative lenders provided 32.3% of the non-agency originations, the same as in the second quarter but down 6.7 percentage points from the same quarter last year. “Rising spreads and interest rate cap costs have made some value-added floating rate deals more difficult to execute,” the report said. “CLO issuance slowed to a trickle, with only four deals totaling $3.39 billion in Q3.”

A year ago, life insurance companies were 20.1% of the non-agency loans. That was up to 26.2% in the second quarter, but by Q3, down to 16.7%. CBRE estimates that life companies will become more selective as they come to filling their annual allocations.

CMBS loans took a big drop. In Q3 of 2021, they represented 17.6% of non-agency loans. Now, 4.6%. “Industrywide CMBS origination volume fell to $13.3 billion in Q3 2022 from $20.8 billion in the previous quarter and $29.2 billion in Q1 2022,” CBRE said. “CMBS spreads have widened, making loan quotes less competitive.”

As CRE experts have been telling GlobeSt.com, LTV ratios in loans are down while interest rate caps have soared and debt yields are up. Lenders are clearly telegraphing that they consider current conditions risky. “Despite these changes, the percentage of loans carrying interest-only terms increased to an average of 63.8% in Q3 2022,” CBRE noted, which itself would seem a risky move and a sign that borrowers weren’t able to pencil deals any other way.

The MBA expected this would be a hiccough, with borrowing and lending to rebound in 2023, hitting $454 billion in multifamily and $872 billion overall. Still no 2021, but strong. That was last quarter before the multiple 75-basis point baseline interest rate hikes from the Fed and ongoing inflation.

Source: “Rising Inflation and Interest Rates Has CRE Lenders Pumping the Brakes“

On the heels of yet another Fed rate hike, the commercial real estate industry is feeling the painful effects of both higher capital costs and lower loan amounts.

Borrowing costs have doubled in the past six months. And rising rates and growing certainty that Fed policy will push the country into a recession is creating dislocation in capital markets. Large banks in particular have largely moved to the sidelines on commercial real estate lending, and first mortgage lenders across the board—including Fannie Mae and Freddie Mac—are dropping loan amounts based on higher costs of debt service coverage.

“Not that higher interest rates weren’t warranted, but the speed at which the Fed is pushing rates has shocked the market,” says Richard Ortiz, co-managing partner at Hudson Realty Capital. Some borrowers are effectively frozen, uncertain of how to respond and how to recapitalize, while lenders also are uncertain of how to lend in a market where there is so much turbulence and uncertainty, he adds.

Although there’s not much lenders can do to lower their rates, they are searching for solutions to keep capital flowing. “We have really pivoted our focus over the last nine months to try to be reflective of the new reality we’re dealing with,” says Scott Larson, managing principal at Pangea Mortgage Capital (PMC). The middle market balance sheet lender is stepping into areas of the market where capital has disappeared.

PMC recently introduced a short-term multifamily lending product to help sponsors weather the turbulence in the CLO market. Historically, PMC has focused on providing bridge loans with two- or three-year terms. It’s now offering a shorter term multifamily bridge loan at 12 to 18 months to help borrowers realize business plans. The short-term bridge loan is coming into play both on acquisitions and construction projects that need more capital due to project delays or cost overruns. “We’re just really trying to provide a temporary solution for sponsors until things stabilize,” says Larson.

Short-term solutions are a common theme. For borrowers that are coming off a bridge loan or construction loan, oftentimes they are opting to extend if they have extension options. “We’re seeing a lot of our borrowers just extend out their existing debt and hoping that there will be cheaper options available in the future,” says Shlomi Ronen, founder and managing principal of Dekel Capital, a Los Angeles-based real estate merchant bank.

New solutions emerge

Red Oak Capital Holdings is an existing bridge lender that is expanding its offering of fixed-rate bridge loans to include three new products—a core, core-plus and participating bridge loan program, as well as a renamed opportunistic bridge loan program. “Floating rate transactions aren’t nearly as viable or as efficient as they were six to eight months ago. So, a lot of borrowers are transitioning to fixed-rate lenders, especially unlevered fixed-rate lenders such as ourselves,” says Gary Bechtel, CEO, of Red Oak Capital Holdings. “We’ve seen a huge demand for our loans, which is why we’ve expanded our loan program,” he adds.

Red Oak’s core and core-plus products are being funded from its Oak Institutional Credit Solutions debt fund, with strategies on the more conservative side of the bridge lending spectrum, notes Bechtel. The core loan program in particular provides a placeholder capital solution for borrowers, such as those waiting for the market to stabilize in order to sell an asset, he adds.

The opportunistic and participating bridge loan programs are funded from capital raised through broker-dealer and RIA channels and tend to be more aggressive in their structure, pricing and risk tolerance, adds Bechtel. For example, on its opportunistic bridge loans, Red Oak offers up to 75 percent loan-to-value (LTV) and up to 90 percent loan-to-cost (LTC), based on the stabilized value or transaction underwriting.

Its participating bridge loan program also includes an equity component from Red Oak in exchange for a percentage of the value creation realized in the project at sale or refinance. The product offers up to 75 percent loan-to-value (LTV) and 100 percent loan-to-cost, depending on transaction underwriting. “That program is for projects that have a very heavy lift component where you are acquiring an asset that is going to be repositioned, such as renovated and re-tenanted or converted to some other use,” says Bechtel.

Agency programs offer liquidity

Recent volatility in the new issuance CRE CLO market has caused some issuers to need to get creative to price deals. One avenue they have gone down is issuing via the Freddie Q program, which provides, for a fee, a guarantee to the senior portion of the capital structure of loans of similar characteristics to those that have traditionally backed CRE CLOs. “This guarantee helps provide an overall lower cost of capital for the issuer than they could currently otherwise find in the traditional CRE CLO market. This has proven to be a popular move and the pipeline for Q issuance, is filling up quickly,” says Rob Jordan, head of CMBS Product at Trepp.

Broadly, the GSEs also continue to be a good source of capital for multifamily borrowers. For example, Hudson Realty Capital is working on a $30 million construction loan for a ground-up multifamily construction project in Salt Lake City that is being financed through the HUD (d)(4) program. “The borrowers were unable to get their banks to commit, not so much on the pricing of the loan, but on the proceeds,” says Ortiz.

As they were going through the process, the banks kept reducing the amount they were willing to lend. At the end of the day, there wasn’t certainty that the banks were going to close on the loan. The developer submitted the (d)(4) loan app and received HUD approval very quickly. Once the deal was approved, the borrower also knew there wouldn’t be any deviation based on a credit committee decision, notes Ortiz. “Getting loans through HUD on a more expedited basis these days is really helping that product along,” he adds.

Gap capital lines up

Capital also is lining up to fill the growing gap between the senior loan and equity piece in a sponsor’s capital stack. In some cases, LTVs have dropped from 65 percent to 45-50 percent.  Lenders such as Hudson Realty Capital, PMC and others are lining up to provide mezzanine financing or preferred equity. Although the gap capital space is becoming increasingly crowded, capital providers also are selective in the types of deals they are willing to do. “Also, the ability to come in and structure that gap capital in concert with the first mortgage lender is where certain firms can distinguish themselves,” notes Ortiz.

Gap financing is in demand across a variety of scenarios. For example, some buyers are looking to purchase properties with assumable debt at a lower rate. Finding an existing interest rate that might be at 3.25 percent is a lot more enticing than if they were to originate a new loan and have to take on a 6 percent rate, notes A. Yoni Miller, co-founder at QuickLiquidity. “The problem is, most of these assumable loans are at a low leverage point,” he says. For example, a property that is being sold for $10 million may only have assumable debt of $5 million. Many buyers are coming in with a 25 percent down payment. “So they are turning to us for mezzanine financing to help them bridge the gap,” he adds.

The cost of that capital isn’t cheap, with financing rates typically in the low- to mid-teens and duration of three to four years. Mezzanine loans and preferred equity is often priced in the low to mid teens. “Transaction volume hasn’t been tremendously high. So, there are probably more groups offering that type of capital than there are those seeking it at this point, but that will eventually change as more borrowers are forced to make decisions on their properties,” adds Ronen.

Source: “CRE Lenders Search for Creative Solutions to Keep Capital Flowing“

The short-term borrowing rate is at its highest level since January 2008 after the Federal Reserve raised its key rate by another 0.75 points to a target range of 3.75 percent to 4.00 percent. The early November increase throws gasoline on the already-burning desire from multifamily investors for assumable debt.

“The greatest risk today in closing a new deal is the extreme volatility with interest rates,” says Matt Frazier, CEO of Jones Street Investment Partners, a Boston-based real estate investment firm that focuses on multifamily assets throughout the Northeast and Mid-Atlantic regions of the country. “Once a deal is under contract, and by the time you lock in debt, who knows what the rate could be? If you can completely remove that risk from the equation, you can focus on the fundamentals.”

Jones Street, which owns and operates a portfolio of roughly 4,400 apartment units totaling roughly $1.3 billion in assets under management, is actively transacting deals by using loan assumptions and scooping up quality properties with in-place fixed rate debt, Frazier notes. At the same time, the firm continues to routinely analyze its portfolio, but with additional scrutiny on properties with assumable debt.

“As a buyer we’re interested in deals with attractive debt, and as a seller, we’re very mindful that the capital structure of our assets has become an asset,” he says. “In high interest rate environments, an assumable loan with a lower-than-market interest rate has value. It will help with the marketability of that asset. Sellers with properties that have assumable loans can expect to attract a larger pool of potential buyers and generate a higher sale price.”

Just two weeks ago, Jones Street closed on a suburban infill apartment community with more than 350 units outside of Philadelphia for more than $100 million. The deal included assumable debt with nine years of term remaining and an interest rate below 4 percent.

By assuming the loan, the firm was able to mitigate interest rate risk and ultimately underwrite a greater leveraged return than would have been possible otherwise, according to Frazier.

The attractiveness of an assumable loan largely depends on the length of the term remaining and an investor’s expected hold period. For example, a short-term hold may not complement the loan assumption’s prepayment conditions.

“It’s specific to the buyer—beauty is in the eye of the beholder,” Frazier says, adding that Jones Street is keen to assume longer terms because of its long-term hold strategy.

Though Jones Street would have been interested in the Philadelphia property without the assumable loan, the existing debt made the deal “very compelling,” according to Frazier. If the firm had needed to obtain new financing in today’s interest rate environment, the debt likely would have cost 5.5 percent or more, he speculates.

“Anyone who is in the market right now, looking at a potential transaction—one of the questions they’re going to ask first is: ‘Is there debt on the property, and is it assumable?’” Frazier says. “They’ll be looking at four things: amount of debt, interest rate, length of remaining term and any remaining interest-only term.”

Lower rates and market-beating terms

Geopolitical and economic uncertainty, coupled with the increasing cost of capital resulting from the rising interest rate environment, have put a damper on multifamily sales activity. Banks, pension funds and even some alternative lenders have pulled back on their financing, making multifamily transactions harder to complete. As investors seek smart, creative ways to transact deals, many have turned to loan assumptions.

“In high or rising interest rate environments where credit availability becomes tight, loan assumptions can be attractive to borrowers for several reasons, such as the ability to take on in-place debt with potentially lower rates, market-beating terms, provisions and lender requirements,” says David Le, assistant vice president of acquisitions for Atlas Real Estate Partners, a private real estate firm with offices in New York City and Miami that focuses on multifamily investment and development.

Loan assumptions appeal to investors because fixed-rate debt that was secured in prior years is very attractive compared to today’s higher rate environment. If the loan originated prior to June 2022, the rate on an assumable should be far more favorable than the rate a borrower can currently obtain.

Moreover, loan assumptions often allow sellers to avoid prepayment penalties, defeasance or lockout periods, which may be reflected in a lower purchase price for buyers and a more favorable all-in basis, Le notes.

More complicated than assumed

The complexity of a loan assumption varies by the lender and loan type, with some assumption provisions being more restrictive than others. A buyer’s track record and experience are key pieces in a loan assumption.

And even though “assumability” is built into loan documentation, lenders have approval discretion—meaning there’s no guarantee that a buyer will be able to assume a loan.

“There’s also the risk of not being approved by the lender, which can scuttle a deal especially if there’s not sufficient time left before closing or if financing contingencies were waived,” Le says.

That’s especially true today, given that some lenders—banks and debt funds, in particular—would prefer for loans to be paid off so they can put that money back to work.

“Lenders are incentivized to force a payoff of loans with lower interest mortgages in order to originate higher interest loans,” Le notes. “More importantly, lenders want good loans with good borrowers in order to maintain a high-quality loan pool. [They’re] more likely to approve an assumption if they view the new buyer as an upgrade to sponsorship.”

Last year, when Atlas acquired a multifamily community with more than 800 units in a secondary market, the firm successfully assumed the in-place debt, in part because of its track record and experience. That debt, coupled with the hefty deal size, forced many local players out of the market, according to Le.

Those who hope that assuming a loan is easier than obtaining a new one will be disappointed. Jones Street’s Frazier says the underwriting and approval process is just as rigorous and lengthy, requiring 60 days or more. Most lenders will require the same or stronger credit from the new borrower.

A loan assumption typically leads to lower leverage (loan-to-value). Maximum loan amounts are usually governed by LTV or the income of the property to service that debt, whichever is lower. Today, the LTV test means “nothing,” according to Frazier. “What is constraining loan proceeds right now is the cost of the debt and the ability to service it,” he says.

Low leverage impacts returns and requires a higher equity contribution to assume the loan, according to James Nelson, principal and head of Avison Young’s tri-state investment sales group in New York City and host of “The Insider’s Edge to Real Estate Investing” podcast. Typically, low leverage only works with patient buyers with long-term horizons since low LTV at acquisition can negatively affect returns in the short term.

Source: “Multifamily Investors Fight Rising Rates by Pursuing Properties with Assumable Debt“