On July 6th, the Federal Reserve’s Federal Open Market Committee (FOMC) minutes from its June meeting were made public, and they contained some fascinating information for the real estate sector.
The first was a direct reference to bank lending for commercial real estate:
“Commercial and industrial (C&I) and commercial real estate (CRE) loans on banks’ balance sheets expanded at a rapid pace in April and May. Issuance of both agency and non-agency commercial mortgage-backed securities (CMBS) stepped down slightly in May from its strong pace earlier in the year. Small business loan originations through April were in line with pre-pandemic levels and indicated that credit appeared to be available.”
For a majority of borrowers, residential mortgage credit was “widely available” through the month of May, however independent of the Fed’s observations, persistently increasing rates are discouraging most borrowers. According to information from the Mortgage Bankers Association that Trading Economics has compiled since January, there have been twice as many weeks in which the number of mortgage applications fell in contrast to weeks in which numbers of mortgage applications showed increasing numbers.
The minutes stated that “While refinance volumes continued trending lower in April and May amid higher mortgage rates, outstanding balances of home equity lines of credit at commercial banks posted the first significant increase in more than a decade, likely reflecting a substitution by homeowners away from cash-out refinances.” Bank interest rates for C&I and CRE loans have climbed, and yields on non-financial business bonds are far above pre-COVID levels.
According to Alex Killick, managing director at CWCapital, “Commercial real estate has historically been a hedge against inflation, and we continue to see sturdy rent growth in the multifamily and hotel sectors.” That being said, Killick noted that cost inflation, notably for staffing and insurance, is impacting NOI margins, particularly on office and retail properties where tenants are on long-term fixed rent leases with escalations of 2% to 3% annually, below the rate of expense inflation.
Killick also states, based on Fed notes and plateauing trends of some commodity prices, looming fixed rate loan maturities in 2023 and 2024 represent “the biggest near-term risk in CMBS,” with projected refinancing charges between 1 and 2 percentage points higher than current rates. Where NOI has also been influenced by rising expenses, may go through a level of distress that is greater than anything we haven’t experienced prior to the 2020 COVID default wave,” he adds.
Al Lord, CEO of Lexerd Capital Management, which largely focuses on multifamily – what he claims is a present bright spot. Lord says interest rate increases would negatively influence financing costs of commercial real estate projects and on the margin, we anticipate some projects to be canceled. The demand for rental housing is so robust that, despite increases in the cost of financing MF real estate projects, this asset class is predicted to do well for investors through at least 2023.