It is estimated that $925 billion in U.S. commercial real estate (CRE) debt is set to mature this year, with substantial refinancing requirements in the coming years as well. While a few of these loans will be granted an extension, most will require refinancing. At the same time, numerous traditional lenders (banks) are shrinking their loan books. It is anticipated that the increase in spreads, along with the rise in interest rates, will produce favorable returns in the coming years for investors in CRE debt.
We asked Art Rendak, President, Inland Mortgage Capital, LLC., about the current lending landscape in the CRE space. Rendak addressed the “tight to non-existent” lending practices at traditional banks and any structural issues. He also touched on several factors that will have an influence on CRE lending in the next 12 months.
CM: Tell us why the private real estate debt market is an attractive investment opportunity now?
AR: For the last several decades, Inland Mortgage Capital, LLC (IMC) has believed in the private real estate debt market as an alternative product to borrowers that were looking outside of the conventional banking lending products. As other lenders have entered and exited the market, IMC has been a steady provider of capital. While market conditions may dictate underwriting conditions (i.e. office lending today), IMC believes that now, maybe more than ever, there is a need for non-recourse CRE bridge financing in the $3 million to $15 million space.
Credit conditions at banks are tight to non-existent and reliable providers of capital are nearly a necessity. IMC will continue to provide thoughtful and prudent loan quotes and maintain appropriate credit discipline while underwriting a variety of business plans from light to heavy transitional with experienced borrowers demonstrating the ability to execute. The goal is that the borrower uses our capital to be highly successful while IMC is profitably allocating that capital.
CM: According to Trepp’s April Delinquency report, the aggregate US CMBS Delinquency rate rose 40 basis points to 5.07%, the highest level since September 2021 (when it was 5.35%). Do you anticipate any structural issues in the banking industry as a result?
AR: This is the first CRE crisis in my 34 years in the industry where interest rates were rising while asset values were seemingly falling. One example is in the office sector. I think the fundamental problems with the office market are finally impacting the lending sector. I believe that defaults, deed in lieu of foreclosures and foreclosures in the office sector are just scratching the surface of the ultimate weakness of that market.
Further, the resetting of values obtained by opportunistic buyers will allow those buyers to pursue tenants at rental rates that will be unsustainable for legacy owners given a limited supply of potential tenants. Here in Chicago, it seems there is a headline nearly every business day that some office building is in foreclosure either in the city or the suburbs. In addition, hotels that have not been able to recover from the pandemic and multifamily that was highly leveraged at low interest rates are also getting similar but less frequent headlines.
Nonetheless, I believe the liquidity in the marketplace and the general strength of the U.S. economy will limit any escalation of the crisis and that economic strength will allow regulators and the Fed to manage potential bank balance sheet and/or capital issues.
Most of my banker associates indicate that credit problems in their portfolio are “not that bad.” The big issue for CRE bankers seems to be the lack of payoffs due to relatively stagnant loan exit options. I don’t doubt their honesty, but there must be a lot of CRE loans that were underwritten to relatively low debt yields in the 2019-2022 period. I know I lost out on a lot of those deals. Perhaps those assets are over-performing, or the borrowers were able to pay down those loans or solve any weaknesses those assets may be experiencing.
CM: Name 3 factors that will have an influence on CRE lending in the next 12 months.
AR: 1) Interest rates and inflation: If inflation continues to be sticky, it is hard to see the Fed lowering the federal funds rate meaningfully. This will continue to impede transaction volume and continue to cause lenders to see below average payoff volumes. This will further constrain CRE expansion as banks’ CRE lending volume will continue to be constrained. Further, higher SOFR rates will lead to further capital outlays for interest rate caps and/or stress on debt service coverage ratios.
2) Work from home continues and artificial intelligence proliferation: This will continue to have a meaningful negative impact on the office market leading to further distress. On the bright side, the AI boom should lead to further expansion in the data center property type.
3) Presidential election: The current White House administration has continually mentioned alterations to the section 1031 tax benefit to generate additional federal income tax revenues. Any restrictions on this could further exacerbate the challenges facing CRE and further reduce transaction volumes while potentially negatively impacting CRE values.