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Rising Bond Yields
In response to last week’s CPI report and statements from various Fed members, the bond market is now expecting the Federal Reserve to raise the Fed Funds rate to a higher level than previously thought. Some economists – including former Treasury Secretary Larry Summers – are expecting the Fed Funds rate to be raised to at least 4.5% (perhaps by the end of this year), implying the Prime Rate at 7.5% or even higher. Additionally, 5-10 year treasury bond yields have moved to the mid-3% range, the highest since 2011. In spite of Fed Chairman Jay Powell saying they will be continuing to raise the Fed Funds rate and reduce the Fed’s balance sheet through Quantitative Tightening (QT) until inflation is under control, and that they won’t be cutting the Fed Funds through all of next year, the bond market implies that this will lead to an economic and/or financial weakness or crisis sufficient to cause the Fed to “pivot” and cut rates in 2023. Suffice it to say there is a lot of uncertainty and next year could be interesting.
Real Estate Loan Market Pulling Back
As usual, the bond market is driving continued changes in the real estate lending market. Lenders have continued raising their interest rates, with loan interest rates now in the high 4% to low 5% range, with many lenders in the mid 5% to 6% range. Effective leverage continues to decline as a result of lenders’ Debt Service Coverage Ratio requirements.
Lenders – due to concerns about the economy and real estate market – are generally becoming more selective about their lending, either through tightened leverage metrics, tightened underwriting, or greater requirements for sponsor experience and/or financial strength. Some lenders are going so far as to stop lending entirely, in some cases due to their lack of funding.
Fannie Mae / Freddie Mac / HUD Loans
Leverage, pricing, and prepayment penalty structures for multifamily loans through Fannie Mae and Freddie Mac lenders have been and continue to be less favorable than those available through other lenders. They tend to have tighter underwriting, higher debt service coverage ratios, and higher interest rates than some other lenders. HUD loans are very challenging due to the loan amount and interest risk associated with their very long times to close, especially in this environment. Borrowers can still generally find better loan alternatives elsewhere.
Fragmented Loan Market
The commercial and multifamily lending market is very fragmented. For example, there are approximately 200 lenders that provided loans ($5 million to $100 million) for apartments in just the state of Washington in the last two years; there were over 100 such lenders that provided multifamily loans of between $20 million and $100 million in Washington during the same two-year period. Each of these lenders develops its own lending program and responds differently to the market, the economy, the regulatory environment, and its own competitive situation. With the uncertainty around interest rates and the economy, the differences between lenders are as dramatic as we’ve seen in decades.
How does a borrower know they are getting the best loan proposal available in such a market? We can help with that! Call or email us to get started.
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