Capital Markets Second Half Expectations
The year 2021 is in full swing, and there has been no lack of excitement. As we head into the second half of 2021, the overall commercial real estate finance market is more liquid than it has been for the past year since the COVID-19 pandemic emerged. As the population in the U.S. has increasingly become vaccinated, COVID-19 cases have continued to fall and the economy is reopening. It appears that the perceived risk in the lending market is disappearing, along with the pandemic. Time will tell, of course, if our enthusiastic return to a new normal environment is premature. As we navigate this incredibly fluid market, each lending sector is worthy of its own separate and unique forecast for the second half of 2021.
As we enter the second half of 2021, there is plenty of liquidity in the insurance company sector of the loan market. When COVID-19 hit in March and April of 2020, most insurance companies tapped the brakes on commercial lending. They slowly started lending again after understanding the impact of COVID-19, but took a conservative approach to getting their money out for the balance of 2020. The great news is that most life insurance companies are back and have planned lending volumes in 2021 that are equal or greater to their pre-pandemic numbers.
With their focus on moderate to lower leverage requests secured by industrial, multi-family, strong well-located office, and retail properties, current pricing on typical 10-year insurance company debt averages from 2.50–4.00%.
What is expected in the second half of the year is a shift back into broader product types. Insurance companies generally balance their holdings, but they have been so heavily focused on the industrial and multi-family space over other products for the past year that they will need to start balancing out their portfolios. We expect to see a slightly increased focus on office and retail lending within this sector, as well as a small increased appetite for other products, such as storage and hospitality.
The market for bank lenders is now highly liquid, as the processing of PPP loans has subsided. Banks are providing construction and bridge lending, but in many cases on a conservative and selective basis. The focus has trended toward stabilized assets to mute risk on balance sheets. Expect the second half of the year to be competitive within the bank space, but historically down from the levels we usually expect to see, due to the influx of other lenders in the middle market space.
Credit unions are a serious competitor to banks and continue to grow market share. With little to no prepayment structures, credit unions have continued to grow and develop competitive programs for all major food groups. Credit unions historically played in the small balance loan space and continue to do so well. Expect to see, over the second half of 2021 and into the future, that credit unions will target larger loan opportunities as their borrower base increases. Additionally, expect more program optionality within the credit union space specifically, as it relates to recourse versus non-recourse financing.
The ever-evolving debt fund sector continues to shine and pick up where many banks and other lenders tap out. Designed to provide flexibility, higher leverage, and non-recourse financing to a large community of borrowers, the debt fund space has grown exponentially over the past few years. Expectations are that as funds continue to be raised, albeit at a level never seen before, debt funds will continue to pour money into the commercial mortgage space. Debt funds continue to dominate the bridge and construction marketplace, providing ample capital to developers and owners that generally exceeds the loan to value of most banks and other portfolio lenders. The second half of the year will be very competitive in this space, as debt funds compete over a limited supply of transactions. Pricing will continue to tighten within the sector as the competition increases. For the balance of 2021 and going forward, debt funds should put some of the capital they have raised to work into other areas of the market, including short- to medium-term facilities for stabilized assets.
Freddie Mac and Fannie Mae have been lending throughout the COVID-19 pandemic and continue to do so. As government-sponsored entities, they have helped keep the multi-family finance markets exceptionally liquid during this time. Agency debt involves requiring principal and interest reserves, tax and insurance reserves, and replacement reserves for many loans. Agency debt is still quite competitive for higher leveraged loans in the 65–75% LTV range, but other sectors have recently been able to beat them on most moderate and conservative loan requests. Interest rates in this sector are very aggressive and typically land in the 3.00%–3.75% range.
The second half of 2021 should be strong, as COVID-related restrictions are being lifted and normal underwriting processes have returned. Expect a continued effort from most agency platforms to develop more bridge-to-perm structure in order to capture the transaction volume that has recently been taken by debt funds.
According to a recent article in the Commercial Mortgage Alert, the CMBS market has just posted a record quarter with $30.5B of issuance. Barring any major unforeseen financial or geopolitical event, expect the CMBS sector to continue to be strong for the balance of 2021. With many loans coming due in 2022 and 2023, it is to be expected that investors will move quickly, even if faced with moderate prepayment penalties, to take advantage of the lower interest rate environment and interest-only options that CMBS provides. Interest rates are very competitive in the CMBS market. Because it is generally a higher LTV lender, expect continued focus in the second half on lower leverage opportunities as CMBS tries to win deals that have typically been placed with insurance company lenders.
Michael Kaplan
President | Slatt Capital
michaelk@slatt.com