Tougher Capital Rules For Regional Banks Means More Pressure On CRE Lending

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Federal regulators are set to require regional banks to boost their capital reserves by 3% to 4% to address vulnerabilities in how they manage interest-based assets, according to a Reuters report. This move follows the collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank in early 2023.

Higher capital requirements often frustrate banks, as it restricts funds available for lending and investment. The issue arose partly because banks, accustomed to low interest rates, heavily invested in Treasury and mortgage-backed securities, which lost value when rates rose.

Banks account for government debt using two methods: available-for-sale (AFS), which allows for regular market repricing, and held-to-maturity (HTM), which doesn’t reflect market changes. The latter approach backfired for troubled banks when rising interest rates devalued their HTM bonds, leaving them unable to cover large withdrawals.

Regulators are pushing for more capital to ensure banks can withstand financial shocks. Analysts predict banks may recover about 25% of unrealized losses in the coming years. However, uncertainty remains, with rising 10-year Treasury yields suggesting expectations of higher long-term rates, and additional capital reserves potentially limiting loan availability.

 

Source:  GlobeSt.

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Bank-Held CRE Loans Face Headwinds Despite Origination Gains

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Trepp‘s Q2 2024 analysis of bank-held commercial real estate (CRE) loans shows a modest increase in origination rates, rising from $3.5 billion in Q1 to $3.9 billion. This uptick is attributed to higher interest rates and stricter lending standards, with caution from investors and lenders.

Despite the quarter-over-quarter rise, figures are down significantly from pre-pandemic levels: retail loans dropped 78%, office 65%, multifamily 61%, industrial 52%, and lodging 39%, resulting in an overall decline of 58%. Trepp noted that markets still face “significant headwinds.”

In terms of net charge-offs, office loans lead at 2.25%, down from 2.50% in Q1. Lodging follows at 1%, while retail is around 0.5%, multifamily at 0.1%, and industrial nearly at 0%. Rising charge-off rates for lodging are linked to low loan balances.

Delinquencies increased to 2.01% from 1.83% in Q1, with serious delinquencies rising from 1.57% to 1.75%. While retail and multifamily showed slight improvements, office delinquencies rose to 7.2%.

Occupancy rates declined across all property types. Retail occupancy dropped to 89.8% from 93% in 2019, multifamily fell to 91.9% from 96.3%, and office occupancy decreased from 89.5% to 79.9%. Notably, industrial saw the largest decline, from 94.3% to 85.2%.

Criticized loans varied by location, with San Francisco having the highest percentage at 61%. Other cities with significant criticized office loans include Washington, D.C. (53%), New York (48%), and Atlanta (43%).

 

Source:  GlobeSt.

 

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Unexpected 254K Jobs Growth Probably Means Lower Rate Cuts

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The September jobs report revealed a gain of over 254,000 jobs, with the unemployment rate at 4.1%. This significantly exceeded the Dow Jones economists’ forecast of 150,000 jobs and an unemployment rate of 4.2%. Given these results, it seems unlikely that the Federal Reserve will implement another 50-basis-point interest rate cut at the upcoming Federal Open Market Committee meeting in November.

Not only did the September jobs figure surpass expectations by 69.3%, but previous months’ data were also revised upward—July’s numbers increased by 55,000 and August’s by 17,000, totaling an upward adjustment of 72,000 jobs.

Wage growth also came in stronger than anticipated, with expectations set at 0.3% month-over-month and 3.8% year-over-year. The actual figures were 0.4% and 4.0%, respectively.

The Federal Reserve’s dual mandate focuses on maintaining price stability and achieving full employment. Recently, Chair Jerome Powell has noted that concerns about inflation have diminished, emphasizing the importance of a robust labor market that should not be neglected.

The unexpected surge in hiring and wage growth suggests the economy may be performing better than anticipated, raising questions about the necessity of further rate cuts.

Gina Bolvin, president of Bolvin Wealth Management Group, commented, “With rising oil prices due to heightened tensions in the Middle East and increasing average hourly earnings, the Fed may become concerned about inflation making a comeback. We could see a renewed focus on balancing both aspects of their mandate.”

Oxford Economics echoed this sentiment, stating, “The report makes another 50-basis-point rate cut unlikely. We anticipate a 25-basis-point cut in November and December.”

The markets are responding to this news, with treasury yields on both the 2-year and 10-year notes rising sharply after the unexpectedly strong payroll data and a decrease in the unemployment rate to 4.1%. Quincy Krosby, chief global strategist for LPL Financial, noted that by noon on Friday, the 10-year yield had jumped 10 basis points compared to Thursday’s close.

Looking ahead to potential rate cuts in November, the influence of job numbers could be mixed and potentially volatile. As Oxford Economics pointed out, job growth might weaken this month if the Boeing strike continues, although the resolution of port strikes could mitigate some concerns in the October report.

 

Source:  GlobeSt.

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High Financing Costs, Looming Loan Maturities Among Top CRE Challenges

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The Counselors of Real Estate have highlighted ten current and emerging issues significantly impacting all sectors of real estate, with high financing costs and impending loan maturities topping the list.

Despite recent cooling inflation and the Federal Reserve’s first anticipated rate cut announced in September, high financing costs continue to burden the commercial real estate market. Investors, who had hoped for as many as five rate cuts this year, are facing disappointment, which is dampening expectations for commercial properties, according to James Costello III, chief economist at MSCI Real Assets.

“Higher costs undeniably complicate the assessment of market value and the feasibility of deals,” Costello stated. “On a brighter note, the sharp decline in transaction volume seen last year is beginning to stabilize.”

Nevertheless, Costello warned that transaction volume could dip again in the third quarter, emphasizing that rate cuts alone may not stimulate deal-making.

To reignite transaction activity, both buyers and sellers must engage in the market. Currently, many owners are hesitant to sell, while buyers are cautious due to high prices, often waiting for opportunities to acquire distressed assets.

The real estate sector is struggling to address a significant amount of impending debt maturities, as noted by Constantine Korologos, clinical assistant professor and principal at New York University’s SPS Schack Real Estate Institute. Almost $1.8 trillion in commercial real estate loans are set to mature by the end of 2026, according to Trepp.

Lenders have been extending and modifying maturing debt, anticipating lower interest rates, new equity capital, or improved net operating income (NOI). However, Korologos warns that this strategy has limits.

“If, or more likely when, these extensions reach their endpoint, lenders will face a growing number of challenging loans to manage,” Korologos explained. “Banks hold a large portion of this debt and have limited options due to regulatory constraints. They can’t keep extending loans without adequate capital reserves.”

For borrowers with near-term maturities, the new debt service payments could rise by 75% to even 100% compared to their previous loans. This increase in payment obligations elevates property values and complicates refinancing efforts as values reset.

“Even if interest rates decrease as expected, it may not suffice for borrowers facing maturity balances that are too high to refinance,” he added. “This scenario is likely to lead to a shakeout among less stable operators and owners lacking sufficient capital.”

 

Source:  GlobeSt.

 

 

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Multifamily Momentum Trends Up on Lower Debt Costs, Higher Cap Rates

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The multifamily real estate market is experiencing a positive shift, fueled by lower debt costs and increased cap rates. Many buyers who had been waiting on the sidelines due to financing challenges and softer market conditions are now starting to re-enter the fray, according to Marcus & Millichap’s third-quarter national report on the multifamily sector.

From July 2023 to June 2024, the average cap rate for multifamily transactions climbed to 5.8%, marking an increase of 110 basis points from last year’s record low. This is the highest cap rate seen since 2014. At the same time, sale prices are beginning to stabilize, as reduced uncertainty in financing allows buyers and sellers to negotiate more effectively.

Vacancy rates remained stable nationwide in the first half of 2024, following a 90 basis point increase the previous year. Primary markets, particularly urban centers, have exhibited the most consistent vacancy rates over the past year. Additionally, institutional investment activity appears to be rebounding, with dollar volume rising significantly in July and August.

While some areas are experiencing mild supply pressure—especially outside the Sun Belt—markets like Chicago, Cincinnati, Cleveland, Milwaukee, Pittsburgh, and St. Louis have seen rent growth supported by inventory expansion below 2%.

In the first two quarters of 2024, the multifamily sector achieved a net absorption of nearly 260,000 apartments, surpassing last year’s total by 35,000 units. This growth in household formation, combined with easing inflation, helped keep national vacancy rates steady at 5.8% at the start of the second half of 2024. However, this rate remains 40 basis points higher than the long-term average for the second quarter, as a historic level of construction continues to meet strong demand.

Currently, there are about 1 million multifamily units under construction across the country, which may create short-term supply pressures. Nonetheless, project starts have dropped by more than 18% year over year in July, and permit requests have decreased by 15%, indicating that development activity may have peaked.

To remain competitive, many property operators have begun offering concessions, with the percentage of apartments providing discounts rising to 14.1% in August 2024, up over 500 basis points from the previous year. While concession activity among Class A properties has stabilized after peaking in March, discounts are still prevalent in Class B and C apartments.

The upward momentum in the market has led to a 4% increase in annual rents for lease renewals, contrasting with a 0.8% decrease for new tenants. Many renters are opting to remain in their current homes due to challenges in first-time homeownership; only 26% of U.S. households qualified for a median-priced home loan from Freddie Mac in the second quarter of 2024, compared to a decade-long average of approximately 46%. The apartment renewal conversion rate also saw a rise, reaching 54.9% in August 2024, up 150 basis points year over year.

 

Source:  GlobeSt.

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Investors To Remain On Sidelines Until 2025

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Despite market fluctuations, many investors and property owners report stable real estate values and rents, with expectations that commercial real estate (CRE) will remain steady for the rest of the year.

A recent survey by Matthews Real Estate Investment Services found that 55% of investors noted unchanged property values in the first half of the year, while 46% reported stable rental rates. Around 30% saw declines in values, with only 2% experiencing significant drops. Conversely, 30% reported increased rents.

These mixed results may be linked to Class A developments in the Sunbelt region, which have driven up average rents but also increased vacancy rates. Half of the investors rated their CRE investments as average, with 33% rating them as good.

Looking ahead, respondents anticipate flat values and transaction volumes, alongside a modest 25-basis-point interest rate cut by year-end. However, many believe that significant transaction activity may not resume until next year.

Concerns remain regarding the retail sector, particularly for restaurants, while multifamily properties are projected to perform best in the latter half of 2024. Investors largely plan to remain cautious due to challenges in finding suitable properties, with some expecting the best buying opportunities to arise in late 2025.

Overall, the primary concern for CRE in the coming months is a potential economic downturn, overshadowing worries about market saturation and interest rate fluctuations.

 

Source:  GlobeSt.

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The Five Largest CMBS Loan Losses

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In August, CMBS losses saw a significant decline, dropping from $119 million in July to $47.2 million, affecting nine loans with an average loss severity of 55.20%. This marked the second-lowest monthly losses over the past year, with only November 2023 recording lower losses at $36.4 million.

The 12-month average disposed balance also fell from $305.5 million in July to $277.7 million in August, with a total of 129 loans disposed, amounting to $3.33 billion. Incurred losses for the year reached $2.108 billion, reflecting a loss severity of 63.28%.

The largest losses in August included:

  1. Bella of Baton Rouge: This multifamily property experienced a loss severity of 92.96%, with a disposed balance of $9.5 million and a realized loss of $8.9 million. Its value plummeted from $16.6 million in 2015 to $5.9 million in 2024 due to past flooding.
  2. Loyalty and Hamilton: An office building in Portland, OR, saw a 90.94% loss severity, with a disposed balance of $11.2 million and a loss of $10.1 million. Its value dropped from $20.2 million in 2017 to $3.0 million in early 2024.
  3. Mall de las Aguilas: This retail property in Eagle Pass, TX had a disposed balance of $21.7 million and a realized loss of $12.2 million, translating to a loss severity of 56.23%.
  4. Washington Square: A student housing property in Schenectady, NY, recorded a disposed balance of $13.0 million and a loss of $5.6 million, with a loss severity of 43.19%.
  5. Glenwood Farms: This mixed-use property in Richmond, VA had the lowest loss severity at 9.41%, with a disposed balance of $9.8 million and a realized loss of $922,533.

Overall, August’s performance suggests a temporary reprieve in CMBS losses amidst ongoing market challenges.

Source:  GlobeSt.

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Anticipated Rate Cuts May Not Offer Quick Relief For CRE

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Anticipation is building as the Federal Reserve’s Federal Open Market Committee prepares for a potential interest rate cut. According to CME FedWatch’s 30-day fed funds futures pricing, there is a 69% chance of a 25-basis-point reduction and a 31% probability of a 50-basis-point cut.

Despite hopes that rate cuts might ease the refinancing pressures faced by many in commercial real estate (CRE), the actual impact remains uncertain.

Any rate cut is expected to be modest. FedWatch indicates a 77.5% chance of a total reduction between 100 and 125 basis points by the Federal Reserve’s December 12, 2024 meeting. Whether this will be sufficient relief depends partly on lenders’ decisions regarding their spread. According to Clark Finney, Vice President and Director at Matthews Real Estate Investment Services, the effects on asset values are complex and not easily predictable.

Lenders may not fully align with the Fed’s rate changes, especially if Treasury indexes are used for pricing coupons. Finney points out that CRE deals often anticipate rate changes well in advance. For example, the 10-year Treasury yield fell from 4.09% at the end of July to 3.65% by September 10.

A swift return to ultra-low rates is unlikely, as the current economic conditions are not as severe as those during the Global Financial Crisis or the COVID-19 pandemic, which led to rapid rate cuts.

Even if borrowing rates decrease promptly—though this is not guaranteed—cap rates usually take six to nine months to adjust. This lag provides investors an opportunity to act before the broader market fully absorbs the Fed’s actions. For instance, an investor might find a property with a 6.5% cap rate while financing costs are at 5.5%.

Ryan Severino, Chief Economist and Head of US Research at BGO, told GlobeSt.com that the short-term outlook for CRE equity involves a gradual increase in investment volumes and valuations. Cap rates are expected to compress more significantly, and total returns should improve as both short- and long-term yields decrease.

Regarding the short-term credit market, Severino anticipates a gradual rise in debt origination volumes as borrowing costs decline. However, loan performance will vary by property type, with offices facing ongoing structural challenges and multifamily properties dealing with issues related to variable-rate debt that has been affected by rising interest rates.

 

Source:  GlobeSt.

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Regulators Crack Down As CRE Loan Losses Pile Up

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U.S. banks are grappling with increasing delinquencies in commercial real estate (CRE) loans, which climbed to 1.4% in Q2. This marks the seventh consecutive rise, driven by high vacancy rates and falling office building values. In response, banks are boosting loss reserves and slowing new loan issuance, with CRE loan growth slowing to 2.2% year-over-year in Q2.

S&P Global forecasts a peak in CRE loan maturities in 2027, with $1.26 trillion expected to come due. For 2024, $950 billion in CRE mortgages are maturing. Federal regulators are permitting loan extensions but are keeping a close watch on banks with high CRE exposure.

Recent M&A activity, such as Bank of America’s $2.9 billion acquisition of Washington Federal Bank’s properties, reflects increased regulatory attention. Despite this, current delinquencies are lower compared to the 2008 financial crisis, thanks to stricter underwriting standards.

The Federal Reserve is likely to cut interest rates soon, but with new CRE loan rates significantly higher than those maturing, the impact may be limited.

 

Source:  SFBJ

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The Yield Curve Is Moving Back To Normal. Does It Matter Anymore?

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For years, economy watchers have kept an eye on the yield curve. Inversion — when a shorter-term Treasury yield runs higher than a longer-term one, typically the two-year and the 10-year — has long been considered a predictor of recession.

The 10-year and two-year inverted on July 5, 2022, setting a new record. But so far, no recession. This is one correlation whose failure at prognostication would be welcome at the moment.

It’s been showing signs of reverting to normal. The two yields ended August 27, 2024, equal to 3.83%. On the 28th, the 10-year was one basis point above the 2-year, officially being a disinversion, however, on both the 29th and 30th, they were equal again. Then, September 3rd brought the two-year at 3.88%, four basis points above the 10-year’s 3.84%. After, the 10-year over 2-year, was 3.77% over 3.76% on the 4th; 3.73% under 3.75%; on the 5th; and 3.72% over 3.66% on the 6th.

In other words, the state of an inversion or not seems to be in an economic limbo. At this point, what does it all mean?

According to the Financial Times, there are two camps, both looking at the changes as investor expectations of coming interest rate cuts by the Federal Reserve. One says that the end of an inversion is a sign of a coming recession.

Deutsche Bank strategist Jim Reid told the FT that “we’re not out of the woods yet,” and that “the last four recessions only began once the curve was positive again.”

James Reilly, an economist at Capital Economics, told the paper that disinversion “has tended to precede recessions in the past . . . this move in yields is a symptom of investors’ worries rather than a new cause for alarm.”

No one knows with certainty the answer because all the factors are correlations that may not be causations. The Federal Reserve Bank of St. Louis’s FRED site has running data, starting June 1976, of the 10-year yield minus the 2-year yield. When the number is positive, the yield curve is normal. When it is negative, there is an inversion. Over that period, the timing between the start of an inversion and the following recession was roughly five months at the short end and 23 months at the long end. The current cycle already far exceeds the longest previous period.

Supposedly the Sahm Rule, which shows a correlation between changes in unemployment and the inception of a recession, says there may be a recession already. Claudia Sahm, the economist for whom the rule is named, has been cautious, having written in July that it “is likely overstating the labor market’s weakening due to unusual shifts in labor supply caused by the pandemic and immigration.”

Perhaps the best approach is to consider the potential impact of rate cuts. There are three meetings of the Federal Open Market Committee left in 2024. Markets have priced in a quarter point in September with a 40% chance of a 50-basis-point cut instead, the FT reports. And they expect just over 100 basis points of cuts by the end of the year. If good economic news continues, the Fed might make three 25-basis-point cuts and December’s meeting is in the middle of the month. There’s a limit to how large the total cut in rates could happen in the immediate future.

 

Source:  GlobeSt.

 

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