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Here are 7 key takeaways from the state of real estate capital markets. Learn how interest rates, regional banks and debt maturities all impact capital markets.
The recent failures of SVB and Signature Bank has caused some investors to question the viability of regional banks. However, before the second and third largest bank failures in history, capital markets conditions and loan portfolios had been deteriorating. A new report from MSCI characterizes the state of real estate capital markets as a continuing trend more than an “unexpected shock.”
Prior to the collapse of SVB and Signature Bank, capital flows declined in the second half of 2022 to $842 billion compared with $1.2 trillion during the same period in 2021, a 30% year-over-year decline. This statistic includes property acquisitions, refinancings and construction loans. What drove this decline in capital flows? Property acquisitions dropped 44% and refinancings dipped 23%.
In February 2023, total investment sales volume declined 51% year-over-year to $26.9 billion. For the 12 months ending in February 2023, investment sales declined by 25% to $683 million. Why? Tighter financing terms and declining property prices have led to lower sales volume.
Higher interest rates increase borrowing costs for investors and operators. According to MSCI, borrowing costs on outstanding property level debt increased 4.4% in December 2022. Investors and operators haven’t experienced this level of borrowing costs since 2013.
In 2022, banks grew their commercial real estate lending portfolios, which accounted for 48% of new loan originations in the sector. For the five years prior to the Covid pandemic, loan originations totaled 40%. Who were the largest originators of commercial real estate loans in 2022?
Regional banks and local banks were the largest sources of funding for construction financing. In 2022, these banks had 29% market share, although new construction loan originations increased to 34% as other lending sources retreated from new project financing. Investor-driven lenders were the second largest source of construction financing. In contrast, national banks held the largest market share pre-pandemic. According to MSCI, regional and local banks financed 63% of originations on new hotel construction and 42% of originations on new seniors housing construction.
Relative to other banks lenders, regional banks and local banks offered higher loan-to-value (LTV) ratios – at 66.4%. This includes higher LTVs than national banks, international banks, government agencies, CMBS lenders and life insurers. Only Collateralized Loan Obligation (CLO) lenders (74.4%) and investor-driven lenders (71.2%) had higher LTV ratios.
In 2023, approximately $900 billion of commercial real estate loans will mature. Given the uncertain macroeconomic environment, at least some borrowers will struggle to refinance their existing debt maturities. Why? Fewer lenders, higher borrowing costs and tighter lending standards all serve as a potential roadblock to extending the debt horizon. However, not all borrowers are created equally. For example, of the $900 billion of commercial real estate loans, MSCI estimates that $400 billion, or 44%, are held by CLO, CMBS and investor-driven lenders.
While capital markets remain challenged, capital flows had been declining before recent regional bank failures. Higher borrowing costs, tighter lending standards and fewer lenders have hampered sales volume. That said, for commercial real estate investors and operators, it’s important to parse the data to assess capital markets risk. Headlines often generalize economic doom without discussing specifics on local markets, debt maturities horizons, or individual lender exposure.
One bright spot: many bank lenders have maturities due in 2026 and 2027, when banks will comprise more than 50% of loan maturities. While some borrowers will struggle in the near-term to refinance their debt obligations, many borrowers who hold bank debt will have a multi-year runway until their debt matures. For the latter group, the prospect of a more favorable economic backdrop, including potentially lower interest rates, is not out of the question.
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