The commercial real estate industry has not been able to borrow as much money as of late, leading to a slowdown in dealmaking and a drop in property values, The Wall Street Journal reports. Banks have been hesitant to loan money to CRE office owners and buyers, and when they do, it’s at a higher interest rate.
Banks’ recent loan reluctance is due to increased interest rates caused by high inflation as well as concerns about a possible recession that could cause more loan defaults.
“Banks are exceedingly cautious right now,” Manus Clancy, senior managing director of data firm Trepp Inc., told The Wall Street Journal. “They don’t want to get caught with their pants down.”
A significant drop in amounts CRE owners can borrow
Banks issued $20.6 billion of securities backed by real estate loans during the second quarter of 2022. That’s a drop from $29 billion during the first quarter, per Trepp. Market sentiment soured in June after the Labor Department reported a large increase in the consumer-price index. The announcement indicated that “inflation wasn’t going to be easily wrestled to the ground,” Clancy said.
Meanwhile, banks issued just $3.6 billion in commercial-property securities, known as collateralized-loan obligations, The Wall Street Journal reports. Short-term loans made to developers back these types of deals. Typically, the developers have business plans that include a major upgrade or property conversion. In February, almost $9 billion in collateralized-loan obligations were issued, according to Trepp.
Loan reduction’s impact on CRE
Banks’ hesitation to loan money to CRE owners is a significant blow as many of them depend on debt for their highly leveraged properties. Interest rates were at near historic lows in 2021 and sales volume set records. In 2022, that sales value growth has gone down as inflation, and in turn interest rates, have gone up. Commercial property purchases increased 17 percent during the second quarter of 2022 compared to the same time last year, according to data firm MSCI. However, sales volume increased 150 percent during 2Q21, per MSCI.
Meanwhile, transaction totals during the second quarter of 2022 dropped 22 percent from the same time last year. Fewer transactions are a potential indicator that higher interest rates are hurting the smaller CRE deals, which occur more often than the high-profile deals, Jim Costello, chief economist at MSCI’s real assets team, told The Wall Street Journal.
“It’s the smaller buildings in Toledo or Poughkeepsie,” Costello said. “Those deals have fallen off first in response to this financial shock.”
Property values have also dropped because of high interest rates. CRE property prices have decreased an average of 5 percent from the high mark they hit in March, according to real estate analytics firm Green Street. Real estate investment trusts (REITs) are trading at an average 11 percent less compared to the value of the properties they own, Green Street Managing Director Dave Bragg said.
CRE deals have slowed, but not stopped
Property owners are still making purchases, even if there isn’t as much money available to borrow, however. The Wall Street Journal reported Regent Properties acquired Trammell Crow Center in Dallas earlier this year and plans to purchase additional Sunbelt office buildings, according to Chief Executive Eric Fleiss.
Meanwhile, CRE buyers and sellers aren’t shying away from making deals even as property values dwindle. In the past, they might have waited things out on the sidelines, but the market is starting to adjust. A number of deals are being repriced to help offset the raised interest rates.
“Think about it; before, you were borrowing in the low 2 percent (range). Now you’re borrowing in the low 5 percent range,” Eastdil Secured Managing Director Jeff Scott told The Wall Street Journal. “It’s just math. It’s not someone trying to take advantage.”
Larger CRE firms might look to take some advantage of the market, however. Blackstone is finalizing a new real estate fund, which could total $50 billion when combined with other firm capital, to engage in global real estate deals, according to Blackstone President Jonathan Gray.
“This is a very advantageous position given the current environment,” he said.