As Markets Calm, Uncertainty Persists

Micro View – Current CRE Capital Markets

The week of March 23rd-27th saw unprecedented volatility in the commercial real estate capital markets. One bank raised their 5-year rate from mid 3% to low 4% to high 4%, all within one day. An additional wave of banks exited the market indefinitely or paused all originations for 60 days. The banks who continue to originate have tightened underwriting standards, reduced cash out financing, and implemented 3-12 month interest reserves. Others have implemented floors between 4.5% and 5% – which creates a borrowing environment that dramatically changes a borrower’s cost of capital.

Later in the week, as the details of the CARES (Coronavirus Aid, Relief, and Economic Security) Act emerged and further Federal Reserve support (Quantitative Easing) came into play, credit spreads contracted and the market settled down. We noticed the following optimistic developments:

• Dozens of banks reopened their UW desks for quality assets – Industrial, Multifamily, Office, and Self-Storage
• CMBX (the secondary CMBS market) resumed trade, providing much needed visibility into potential CMBS credit spreads. The initial information dictates spreads significantly wider than recent pre-COVID securitizations, which has lead to calls to restart the Term Asset-Backed Securities Loan Facility program (TALF)
• Foreign National Banks have remained active and are pursuing most asset classes
• Select retail assets are actively pursued by capital – GSP facilitated various high leverage loan applications for infill Los Angeles retail
• Fannie/Freddie, the “backstop” of multifamily lending, continues to quote deals despite a huge increase in volume.

The strongest indication of positivity was the cheapest rate secured by GSP throughout this downturn for a full leverage Fannie Mae loan. The rate was locked on Monday 3/30/2020 at a spread of 225 over the 10-year Treasury, resulting in a 10-year rate under 3% However, this loan was originally put into application in February and market conditions shifted several times while it was in process. In fact, last week, the spread would have been nearly 100 basis points higher!

Please see the below closing comments for more information on the macroeconomic views.

Please join us on Friday, April 3rd at 10:00 am PDT for our Finance Fridays webinar “COVID-19, The Macro Economy and Commercial Real Estate“.

The featured panelists are Stuart A. Gabriel, Arden Realty Chair Professor of Finance and Director, Richard S. Ziman Center for Real Estate at UCLA and JP Conklin, Founder and President at Pensford.

The discussion will be moderated by Gary M. Tenzer, Principal/Co-Founder at George Smith Partners and David Pascale, Senior Vice President at George Smith Partners.

Topics will include:

• Why have Treasuries dropped but interest rates gone up?
• How does the CARES Act benefit CRE owners?
• What is needed to restore stability to the capital markets?
• How does the economy recover from a total shutdown?

REGISTER HERE

CLOSING COMMENTS

Macro View

The Prologue: Quantitative Easing (QE)

On March 15th, as the Fed pointed its sights on a 0-to-25bp funds rate, it concurrently announced it would purchase $700B of long-term Treasury debt and MBS. The idea, quantitative easing, would flatten the yield curve by increasing the value of long-dated treasuries. Theoretically, this would begin a cascade of events: reduce yields on long-term mortgages/corporate bonds  incentivize corporate investments  encourage development. The aggregation of these events, as shown in the aftermath of the 2008 great recession, would be a stronger economy.

Unlike previous uses of QE, the impact of the COVID-19 pandemic was too abrupt and volatile for an economy already strained with an inverted yield curve.

Enter the CARES Act

The $2.2 Trillion bipartisan bill, the largest ever stimulus (more than twice as large as the combined stimulus packages offered in 2008/2009), signed into law March 27th, provided an immediate boost to our economy. The well-received package was a timely factor in stabilizing the CRE Capital Markets last week. By-and-large the bill was not designed to impact CRE directly. Instead, it offers businesses, municipalities, and individuals security during the COVID-19 crisis.

Commercial Real Estate: Stimulus Indirect Impact

While the CARES act does not explicitly funnel support to commercial real estate, the stimulus greatly improves the underlying economic climate which provides more certainty for the Capital Markets.

CRE Taxes and Capital Gains – The stimulus bill lifts restriction for three years (2020 included) on losses in real estate investments, to minimize taxes on other capital gains.
Hotels – Indirectly offers hotels loans, grants and tax help – since most qualify as a small business. Senate bill language defines each individual hotel as a business. Unemployment will help the projected 4MM hotel employees who have been or will be furloughed.
Retailers – The bill will allow money of overpaid taxes (Est. $30B) to flow back to firms.
Restaurants – The decision to define small businesses at 500 or less employees means that many franchisees will qualify.
Multifamily – Owners can request a forbearance of up to 90 days on federally back mortgages. Tenants cannot be evicted during forbearance period for non-payment of rent/fees. From March 18-May 17th Servicers are prohibited from initiating foreclosure and processing foreclosure-related evictions. Landlords who do not have federally backed mortgages or subsidized renters will receive a variety of responses from their banks, but there is no uniform process.

We are attentively watching the influence the following events will have on our economy:

• The virus curve and rate of new infections
• Availability of medical treatments for infected patients
• Readiness of widespread testing and improved result turnaround times
• Moves in interest rates, credit spreads, and equities
• Potential news about a fourth stimulus package shaping up for late April/early May, Both the administration and congress have indicated that they favor a large infrastructure bill as the next step. This would be a major shift away from emergency measures to providing ongoing economic stimulus
• Economic indicators:
  • Next Thursday’s weekly initial jobless claims number
  • Revised earnings guidance from companies
  • Manufacturing data points
  • Personal income and spending data for March. In February, there were no shutdowns, sporting events and theaters were open, and consumers were very active. March data will show a large change so this number will be closely watched.

If you have an inquiry regarding George Smith Partners’ commercial real estate financing, please contact your GSP representative or Todd August, Chief Operating Officer at (310) 867-2995 or taugust@gspartners.com