Industry Insights with Matt Illias and Danny Natsch
By Matt Illias, Managing Director and Danny Natsch, Senior Managing Director, Ethos Commercial Advisors
Oh, how things have changed. A year ago, the Ethos Commercial Advisors debt and equity group was closing loans for commercial and multifamily properties in the mid 2.00% range for 10-year terms. Fast forward 12 months, and those same types of transactions will have an interest rate in the 5.25% to 5.75% range. Historically speaking — still a good rate — however, this 300+ basis-point rise in interest rates for permanent debt has significantly slowed the acquisition market and reduced borrowers’ desire to refinance. This rise was caused by two factors:
1. The perception of a recession. Investors’ flight to bonds drove long-term treasury yields higher; the 10-year treasury has risen 170 basis points over a year.
2. The Federal Reserve raised short-term borrowing rates to counter the rise in inflation, which has had a more dramatic effect on bridge and construction debt.
Investors across the board are feeling the impacts of these rises in interest rates. The dawn of a new age of commercial financing is upon us, and the uncertainty within the market is being felt by all parties, including buyers, sellers, lenders, and brokers. This business always has been, and always will be, about relationships. Working with a trusted sales broker and mortgage broker creates confidence in volatile markets and provides certainty to close.
Higher leverage debt has been increasingly hard to obtain due to the steep rise in interest rates. Buyers are unable to achieve the 75% leverage to which they grew accustomed in Summer 2022, with debt service coverage limiting most loans. Lenders generally underwrite to a 1.25x debt service coverage for commercial properties and will go down to a 1.15x or 1.20x for multifamily. With interest rates at 5.75%, leverage now tops out around 65% … possibly 70%, which requires more equity to close, therefore slowing the acquisition market. Sellers must adjust price expectations in order to correct these issues, and consider the sale prices in 2021 and early 2022 as relics.
For lenders, the appetite to deploy capital has become polarized. We have many lenders, life companies, banks, and credit unions who are eager to lend on retail, industrial, multifamily, and self-storage, and there are other balance sheet lenders who are restrictive in their lending appetite or have stopped lending altogether. There is apprehension among many capital providers who are holding large amounts of construction and bridge debt on their balance sheet, and having a difficult time getting that debt off their books. Projects finishing construction in 2022 with floating-rate construction debt saw their rates go from 3.00% to 7.50%+. This is a short-term problem, however, banks, credit unions, and debt funds that are carrying these loans are not seeing them paid off, which impacts their ability to fund new permanent loans or construction loans. For banks and credit unions, the solution is to obtain more deposits, and more are now making this a larger requirement.
As a debt and equity advisory firm, we partner with investors and developers to capitalize their projects and support them through the lifecycle of the deal, whether that be land acquisition and entitlement, construction, bridge, or permanent financing. Ethos Commercial Advisors works with Fannie Mae, Freddie Mac, life companies, banks, credit unions, debt funds, private equity firms, and CMBS. In 2022, our team closed more than $350 million in transactions with these sources across industrial, land, multifamily, office, and retail. In 2023, it’s going to be a whole new ball game for getting deals done, and Ethos has the ability to get your projects financed.