The Capital Spigot: Financing Sources Converge, Interest Rates Diverge
The commercial real estate finance ecosystem has seen an influx of capital flowing into debt funds and other lending sources over the past decade - and the heightened competition has significantly tightened pricing across all lending participants in the industry. During MBA’s Commercial Real Estate Finance/Multifamily Housing Convention, I joined a panel with lenders, debt fund representatives, and intermediaries to discuss how the lines between capital sources are becoming blurred as investors chase yield wherever they can find it.
The Impact of Competition
Institutional investors are seeking yield, and as the U.S. Treasury rates have remained relatively low, fundamentals in real estate have continued to be strong. These dynamics have drawn in foreign capital, from countries where investors and borrowers have struggled under low or negative interest rates.
Following the global financial crisis, some large banks that were active lenders closed, and those that remained were under regulatory constrictions, and other lending sources flowed in to fill the gap. Today banks are getting their market share attacked from all sides, life company, CMBS and debt funds.
Yet as it’s been easier to raise capital, it’s also been harder to invest. The result is non-bank lenders, such as debt funds, have tightened their pricing to be more in line with banks. Even though the pricing of non-bank financing has come down, banks have been hesitant to loosen their underwriting standards in order to ensure loan quality. At the same time, the federal agencies (Fannie Mae and Freddie Mac) are extremely active, and offering fixed-rate product, encroaching on both debt funds and banks. And through mergers and acquisitions activity, major financial institutions are taking ownership stakes in debt funds, mortgage banking firms, and technology platforms to compete in this new ecosystem.
2017 was the first year since the financial crisis in which KeyBank Real Estate Capital generated more loan volume off balance sheet than on. Our off balance sheet business distributed more than $11.5 billion in permanent mortgage financing through Freddie Mac, Fannie Mae, Commercial Mortgage Backed Securities (CMBS), and FHA.
There’s a tremendous amount of capital looking to be put to work at different places in the capital stack over the life of a project. The lending sources are filling different niches – financing construction lending, rehab programs, stabilized properties, and transitional projects.
The MBA CREF panel discussed three trends propelling capital flow in the U.S.: interest rate divergence, positive perception of U.S. market fundaments, and a relatively stable political system. However, if any of these three change, the capital spigot could slow. One issue on everyone’s mind is whether a slowdown in foreign investment would cause a big correction. Panelists don't believe this will happen and that real estate will remain a favorite investment class, particularly for pension funds which value real estate’s growth and returns.
Rising interest rates could cause a cooling in the hot market, but perhaps not a dramatic one, as lenders have been pricing in an increase in projections. As long as rate changes remain gradual, either up or down, the market should be able to continue to function in a reasonable fashion and activity should remain strong.
The Key to Deals in a Shifting Cycle
As the market approaches the next part of the cycle, it’s important for investors to choose lenders who work collaboratively within the capital stack to make deals happen. KeyBank Real Estate Capital specializes across the whole lifecycle of the loan from origination to servicing, and offers an integrated platform tailored to meet your investment goals.