The Lending Market Landscape at a Time of Economic Uncertainty
The commercial real estate lending climate has dramatically begun to change since the days from 2012 to mid-2022 went the debt markets seemed invulnerable and recovery out of the pandemic seemed like it was heading down a solid path. Sparked by the first 75 basis point hike by the Federal Reserve of its benchmark federal funds rate on June 15, 2022, “marking the central bank’s first three-quarter of a percentage point hike since 1994,” the debt markets began to tighten in the second half of 2022, leaving a prevailing uncertainty over how high the Federal Reserve will raise interest rates to rein in inflation and ward off an impending recession as the Fed continues its aggressive strategy leading to further large interest rate increases in July, September and November. The pace of investment sales volume has slowed and is anticipated that in the coming months there will be a lot less transaction activity since “increased cap rates trail increasing interest rates.”
Those borrowers that view the increased interest rates as a short-term issue “are trying to secure shorter-term floating-rate debt with flexible prepayment penalties instead of locking in long-term fixed rates;” while across the table, lenders always proceed more cautiously in an environment of rising interest rates, continuing to be conservative on loan-to-value calculations and less willing to lock into rates when costs are continuing to rise. However, despite the unsettled market with lending becoming more challenging and increased borrowing costs, “one notable difference between now and 2008 is that loans then were underwritten with a loan-to-value base rather than debt service coverage ratio and debt yield base;” and “despite banks pulling back of late, there is still plenty of liquidity on the sidelines to deploy because of government stimulus money rolled out during the COVID-19 pandemic.”