February 25, 2018

Andy Little


by Andrew Little, Special Correspondent

It’s a stretch — a huge stretch — to compare the annual mortgage bankers convention to Major League Baseball’s winter meetings. Similarities include a lot of blowhards talking up the strengths of their clients, rumors circulating, serious discussion and actual deal making.

The convention sets the tone for coming year and, based on the attitude of those present, 2018 is going to be another strong one in commercial real estate.

Several lenders have lower production goals for 2018 compared with 2017, but they are the exception — most are trying to grow their loan portfolios and know they will have to either compete on price, leverage or with creativity.

We expect conduits to press leverage and compete on price, but it is more likely that if you have a low leverage deal, an insurance company will be the best price alternative. As far as creativity, a raft of new bridge lenders are ready and willing to do business.

What is somewhat alarming is that many are backed by funds that come from collateralized loan obligation bonds. So-called CLOs became very popular at the peak of the last cycle up until the Great Recession and, while a legitimate source of capital, the lack of discipline that characterized the late stages of the last cycle can be tied to the lack of oversight on collateralized debt obligation and CLOs in 2007.

A number of programs announced at the convention are worth exploring a bit more. Several lenders have interesting construction permanent programs that are designed to allow borrowers to lock in long-term rates now even though the property won’t be delivered for 12 to 24 months.

High loan-to-cost credit tenant loans easily fit into many lenders’ balance sheets, and construction loans also are available for large-scale apartment projects. A few insurance companies offer 75 to 85 percent loan-to-cost construction permanent programs, and others will fund an apartment project that has only reached break even debt service coverage.

There was concern at the convention over rising interest rates as Treasury yields march steadily higher. Rates pushed higher again in the last month and are currently in the 4 to 4.25 percent range for 5- and 10-year loans offered by life insurance companies, according to the John B. Levy National Mortgage Survey.

Conduit pricing is more expensive and now averages 4.75 to 5 percent for higher leverage loans.

With interest rates moving higher, no one is ready to predict where cap rates will go, but it is clear that the largest impact will be felt in the lowest cap rate asset classes. Today, that would be credit tenant deals and apartments.

On a deal that trades at a 6 percent cap rate and is 80 percent leveraged, a 0.25 percent increase in interest rates (like we saw in the past month) can reduce return on equity by a full 1 percent annually. Reduced equity returns could lead to less interested investors, and that could push cap rates higher.