Commercial real estate investors face an uncertain future as the year comes to a close. Recession fears driven by record-high inflation and surging interest rates have overwhelmed investor sentiment, leaving many wondering what will come next.
Deal volume has also slowed as institutional and bridge lenders become more conservative with how they allocate their funding. The cost of capital has increased, making it more expensive for investors to get deals done.
For multifamily, however, it’s a slightly different story. Multifamily vacancy rates during Q3 tumbled to 4.4%, setting a five-year record low. This year, the asset class still remains one of the best performers industrywide, with investment sales volumes increasing through Q3 in certain property cohorts compared to the year prior.
However, according to experts from NewPoint Real Estate Capital — a real estate lender that provides financing solutions for a myriad of asset classes, including multifamily, affordable housing, senior housing and healthcare — multifamily investors and lenders are still prudent as general economic inconsistency has slowed the sector's refinance and acquisition rates.
“Refinance lending and multifamily acquisition activity has slowed noticeably during the second half of the year,” NewPoint Senior Managing Director of Originations John DeWitt said. “Key factors contributing to this change include loan index rates, loan spread volatility, heightened cap costs and overall hesitancy regarding the U.S. macro economy.”
The acquisition activity in the multifamily sector has been more focused on value-add and lease-up opportunities, mainly in the $25M to $50M price range, DeWitt said. While acquisitions may be slowing as a result of market inconsistencies, borrowers are showing a more robust demand for refinance lending.
Each capital source is taking a unique approach when it comes to navigating the market, given its current obstacles.
Fannie Mae And Freddie Mac
NewPoint Senior Managing Director of Originations Martin Fayer said that agency spreads over the Treasury rate and Secured Overnight Finance Rate increased for the majority of Q3. In early November, fixed-rate spreads flipped and have been trending downward since. However, floating-rate spreads have remained steady.
Fayer added that the 2023 lending caps are now at $75B per agency and no longer feature the requirement for 25% of multifamily loans to be affordable at 60% of area median income. This should enable Fannie Mae and Freddie Mac to be involved in a greater portion of the multifamily market.
Fayer said that national banking institutions continue to remain on the sidelines because of heightened capital requirements. Meanwhile, local and regional banking institutions are being cautiously selective when it comes to midsized deals.
“Regional and international banks are offering five-year fixed-rate loans with flexible payment conditions,” he said. “For many deals, we are seeing rates in the 6.25% range with declining prepayment options begin at 5% during the first year and decrease by 1% every year after that.”
Life Insurance Companies
Life insurance companies have set their sights on assets that are ideally located and with firm sponsorship, Fayer said. Though these companies are becoming more intent on forging deals with shorter-term fixed-rate and floating-rate executions, next year’s allocations have yet to be released.
Traditionally, approximately 80% of a life insurance company’s debt allocation is fixed, with about 20% floating. As the market heads into the new year, time will be the main indicator of how hungry the industry is for fixed-rate and floating-rate loans.
Non-CLO And CLO Bridge Lenders
For noncollateralized loan obligation bridge lenders, a more vigilant outlook on the market is trending.
“Non-CLO bridge lenders are quoting deals as low as the term rate based on Term SOFR plus 300 to 350 basis points for strong deals at 65% loan-to-cost,” DeWitt said. “Though bridge lending activity is slowing, like most other sectors of CRE’s capital markets, value-add and lease-up transactions are a favorable option.”
DeWitt said that for lease-up deals, the 9.25% exit debt yield is what borrowers are paying attention to, while the incoming debt yield is less pertinent.
“For these kinds of loans, debt funds require a two-year cap at 4.5% strike rate,” he said. “On the contrary, debt funds for CLO bridge lenders are focusing on initial debt yields of 6.25% and stabilized debt yields of 8.5%. For both non-CLO and CLO lenders, debt service reserves are now maintaining an interest-only debt service escrow.”
2023 Should Bring Stabilization
Looking forward to next year, DeWitt and Fayer predict that more lenders will return to the market in search of ways to get involved on the shorter end of the yield curve.
“In 2023, there are a few trends to keep an eye out for, including fixed-rate bridge debt, loan spread compression, short-term fixed-rate deals with waning prepayment structures and agencies allowing for rate swaps instead of SOFR rate caps,” Fayer said. “Overall, we’re confident the market will begin to stabilize and show signs of recovery.”