The CRE debt markets remain open and robust
but continue to be fairly disciplined. Outstanding
commercial and multifamily mortgages rose to
$2.9 trillion and $1.4 trillion, respectively, which
represent year-over-year increases of 5.1% and
6.6%.1 Debt growth has been more moderate during
this expansion than in past cycles, due in part to
more cautious underwriting as well as the uneven
recovery in nonresidential structures investment.
Despite solid fundamentals, banks appear to be increasingly cautious in their extension of credit.2 We view this as a reaction more to the current stage of the cycle rather than the deterioration of credit fundamentals. Alternative lenders, which now make up 26% of the CRE lending market and include entities such as REITs and private debt funds, will likely be the beneficiaries if banks continue to pull back. In Q1, finance companies increased commercial/multifamily debt holdings by 13.5% compared to banks’ growth of just 1.1%.1
Average property loan-to-value (LTV) ratios have trended downward and currently sit well below levels seen before the last recession, signaling the CRE space has reduced structural leverage. Debt service coverage declined somewhat as the cost of debt briefly increased in 2018, but has recovered to a near-cycle high of 1.85x as commercial mortgage rates have fallen in tandem with benchmark yields. Low vacancy rates and steady rent growth are tailwinds for debt service coverage going forward.3
The interest rate landscape has undergone a drastic shift, with the Fed first pivoting to a patient stance and now appearing outright dovish. The market is currently pricing in over two rate cuts by the end of 2019, compared to the beginning of the year when the market gave about equal probability to a rate hike and a cut. Long-term rates have fallen in concert, with the 10-year Treasury yield now hovering around the 2% line.4 Looking ahead, low yields will likely keep commercial mortgage rates low, which should continue to drive strong demand for debt financing.
1 U.S. Federal Reserve, Flow of Funds, as of March 31, 2019.
2 U.S. Federal Reserve, Senior Loan Survey, as of April 30, 2019.
3 Real Capital Analytics, as of May 31, 2019.
4 Bloomberg, as of May 31, 2019.
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