Capital and Lending: The Trends to Watch

Article originally posted on HERE on February 15, 2024

Attempting to determine what will happen with the economy, commercial real estate and capital markets over the next 12 months is an activity that could backfire. A year ago, the focus was on a recession, which never materialized. Other issues of concern included record-high inflation and the continued rise of the Effective Federal Fund Rate.

But the recession never materialized, inflation did come down, and the Federal Reserve pressed “pause” on its EFFR rate hike in September 2023.

Though 2023 predictions somewhat fell short of the mark, this didn’t stop Connect CRE from asking experts for their thoughts about trends to watch in the capital markets. The general theme included maturing debt, opportunistic plays, and ongoing restructuring.

Maturing Debt and Banking

The trend on everyone’s mind is the “elephant in the room.” Specifically, debt maturities. More specifically, office debt maturities, with multifamily not far behind. Avatar Financial Group’s T.R. Hazelrigg IV said these maturities will continue pressuring the commercial real estate sector in the coming year.

“Office will continue to suffer from a seemingly permanent, or at least long-term shift in the corporate work environment,” Hazelrigg explained. At the same time, multifamily “will still be stuck with excess supply due to the significant levels of financing we saw in 2021 and 2022.”

Revere Capital’s Jeff Salladin added another wrinkle to the office issue. “If it’s true that only 10% to 15% of office buildings can be converted into multifamily, then what happens to the rest?” he wondered.

The problem is that many previous loans relied on a steady and increasing income flow, which hasn’t happened in many cases. Ivan Kustic with MetroGroup Realty Finance explained that even with ten years of reduction in a loan’s principal, “we are seeing a great many properties not generating sufficient income to qualify for a loan amount large enough to take out their maturing debt.”

Still, Jonathan Lee with Colliers Structured Finance Group said office occupancy has bottomed out. While there are still work-from-home setups, a loss of esprit d’corp is wearing on many companies. “My hope is that 2024 is indeed the low point for office, and the frustrations of c-suite executives finally spill over into higher occupancy levels,” Lee said.

But what about banks? Will they come out of the shadows and be more active lenders? Not really, according to CapRock’s Jon Pharris. He predicted that money-centered banks will remain on the sidelines for much of the year, except for their best “relationship borrowers.” In addition, “construction loans will be difficult to obtain, will be very expensive, and will be available to the best borrowers with strong balance sheets,” Pharris added.

On the other side, Gary Bechtel with Red Oak Capital Advisors indicated that lenders of all stripes might see access to opportunities that offer lower exposure and higher rates or yields. Additionally, “buyers will see opportunities as well, with the ability to potentially acquire an asset at a significant discount and re-set its basis going forward,” he said.

Where the Opportunity Is

Speaking of opportunity, the experts agreed that capital will likely head toward value-add plays and distress. Jeff Erxleben with Northmarq predicted an increase in lender-controlled sales or recapitalizations in the coming year. “Legacy projects capitalized in 2020 and beyond will see the need for additional equity and loan restructurings,” he said, noting that foreclosures could generate buying opportunities.

Lee pointed out other prospects for capital.

“Affordable housing has gotten headlines, but there is still enormous opportunity in that sector, both in ground-up development and existing assets,” he said. Furthermore, as inflation continues hammering working-class incomes, “there appears to be a long runway in affordable,” Lee added.

Despite the high interest rates, depressed values in certain asset classes and continued post-pandemic uncertainty, there’s still room for optimism. Kustic pointed out that the current situation isn’t as dire as past cycles, which saw values decline by 20% to 30% and 15% interest rates. He said capital is still available, especially for conservatively leveraged and well-managed properties.

Uncertainty will likely remain the hallmark in capital markets during 2024, with Bechtel dubbing the situation a “major reset of the industry.” As always, in such scenarios, there will be winners and losers for buyers and lenders. Lenders could take a hit on their loan portfolios. Investors could lose out as well, as property trades hands. Noted Bechtel: “We’re in some interesting times.”