Market volatility is obvious, but just how unpredicatble is it? Since September 1st, the moving 5-day average of the 10-year US Treasury has produced 26 swings of 20 basis points or more.
Additionally, Corporate bond spreads, a typical proxy for fixed rate mortgage pricing, is a roller coaster pushing spreads up over 20 basis points from September 1 to October 21st, and back down nearly 30 basis points since the peak in October.
Basis Buys: The acquisition market has slowed considerably as interest rates make price discovery a challenge. Institutional asset managers are exercising patience awaiting economic clarity. Private capital is moving to the offensive with the void of institutional competition, taking advantage of select opportunities to acquire assets at a reset basis and strong discount to replacement cost.
Defensive Refinances: Near term maturities (6-24 months) and looming rate cap renewals should motivate the exploration of a medium-term (3-7 years) fixed-rate refinance with flexible prepayment options. With a flexible medium-term loan, we can de-risk an investment by eliminating loan covenants and stabilize cash flows through the uncertainty of rising short-term rates.
Offensive Refinances: Prepayment and defeasance penalties are minimal and even “in the money”, making a refinance today something worth considering. Owners with existing CMBS loans on commercial assets should consider exploring a refinance with our balance sheet relationships where we can eliminate hefty TI/LC and capex reserve requirements and eliminate cash trap provisions.
Time the Market: Timing the market is difficult, but not impossible. Running a process proactively is the only way to time the market and put you in a position to act. Recently, we ran a competitive process for a transaction with flexible timing. By clearing the market, we had a competitive set of lenders with term sheets approved. On November 10th, the inflation numbers were cooler than expected and we saw a 30-basis point rally in the treasury market. Our decisive client gave us the order to finalize terms and lock rate which we were able to execute within a matter of hours.
Market Liquidity: As we head into 2023, I am very optimistic about market liquidity. Life Insurance Companies, Fannie Mae, Freddie Mac, and HUD have very healthy 2023 allocations for multifamily and commercial real estate. In comparison to the start of 2022, there is very little deal flow hangover that will jump start 2023 production goals. I anticipate lenders will be aggressive to start the year. In a survey of over 15 life insurance companies, 90% expected allocation targets to remain constant or even a slight increase compared to 2022 and 10% cited a very small reduction in target allocations; that should put life company financing capacity near $70 billion for 2023. Added to Fannie and Freddie volume caps of $75 billion each and 2023 will have a full $220 billion of new capital to work with…and this doesn’t account for CMBS and depository lenders which could easily provide an additional $200 billion of capital if we see continued stability in the market.
Conclusion: Where rates move, no one knows; however, expecting of a swift return to sub 4% rates might get you hit with a wrench. A 5% interest rate environment, though, is within reach. We can have a very healthy and functional transaction market at this level providing positive leverage for retail and office assets and likely near break-even for most industrial and multifamily assets where business plan execution and rental growth can quickly grow into positive leverage and viable investor returns.