Last month, commercial real estate lending experienced a decline for the first time in two years, reflecting the impact of tighter credit conditions and higher mortgage rates on the sector. According to data from Refinitiv, outstanding debt on commercial properties decreased to $5.44 trillion in June, marking the first drop in commercial real estate lending recorded over the past two years. The decline was primarily driven by a slowdown in lending for multifamily properties, as demand weakened in response to rising interest rates. Multifamily property debt alone decreased by $21.6 billion last month, as reported by Capital Economics.
Despite this, commercial property debt still saw modest growth in June, with an increase of only $7.4 billion. However, Capital Economics Assistant Property Economist Charlie Cornes expects that commercial real estate lending will remain weak throughout the second half of 2023. Cornes points to the rising delinquency rate on US commercial mortgage-backed securities, which reached 1.91 percent in June, marking the second consecutive monthly increase. This trend is a result of banks scaling back on lending following the failures of several regional lenders earlier this year.
The reduction in credit availability, particularly for small businesses, has raised concerns about the commercial real estate sector. With approximately $1.5 trillion in debt maturing in the coming years, anemic demand and tighter financial conditions could lead to an increase in commercial mortgage defaults. Experts predict that these factors may cause commercial real estate prices to plummet by up to 40 percent from their peak, surpassing the severity of the 2008 financial crisis, as estimated by Morgan Stanley.
At the same time, the CRE Finance Council (CREFC), the industry association representing the $5.6 trillion commercial and multifamily real estate finance industry, has released the results of its “Second-Quarter 2023 CREFC Board of Governors (BOG) Sentiment Index,” which showed a cautious and modest recovery in market confidence compared to the previous quarter.
The Sentiment Index provides insights into the industry by capturing the perspectives of a diverse range of stakeholders, including balance sheet and securitized lenders, loan and bond investors, private equity firms, debt funds, servicers, and rating agencies.
Derived from the Board’s responses to nine core questions about the state of the CRE finance market, the Sentiment Index tracks the market’s performance before, during, and after the COVID-19 pandemic.
The survey results for the second quarter of 2023 indicate that the overall index value rose from 67.5 to 78.5, suggesting a more positive outlook for the sector. However, several key concerns persist, summarized as follows:
Economy: Respondents’ expectations for the U.S. economy over the next 12 months were divided, with 10 percent anticipating improvement, 35 percent expecting little change, and 55 percent predicting worsening conditions. In the previous quarter, only 2 percent anticipated improvement.
Policy: Regarding the impact of federal government legislative and regulatory actions, 4 percent believed there would be a positive effect, 47 percent expected neutrality, and 49 percent anticipated negative consequences. The sentiment improved slightly from the previous quarter when no respondents expected a positive impact.
Rates: Mortgage rates and cap rates were viewed negatively by 65 percent of respondents, while 6 percent expressed a positive outlook, and 29 percent remained neutral. Sentiment regarding rates improved from the previous quarter when 88 percent held a negative view.
CRE Fundamentals: Expectations for CRE fundamentals remained pessimistic, with 84 percent predicting a worsening situation and 16 percent foreseeing no change. None of the respondents anticipated improvement. These figures align with the sentiment expressed in the first quarter of 2023.
CRE Transaction Activity: Regarding investor demand for commercial real estate and multifamily assets, 25 percent expected an increase, 45 percent predicted stability, and 29 percent anticipated a decrease. Although sentiment improved from the previous quarter, some respondents remained cautious.
Financing Demand: Borrower demand for CRE and multifamily loans/financing is expected to increase, according to 53 percent of respondents, while 29 percent anticipate no change and 18 percent predict a decline. The sentiment reflected a positive trend compared to the previous quarter.
Liquidity: Expectations for liquidity in the CRE debt capital markets revealed relatively balanced sentiment, with 14 percent expecting improvement, 41 percent foreseeing no change, and 45 percent anticipating a contraction in liquidity. Sentiment remained stable compared to the previous quarter.
CMBS Capital Markets: Respondents expressed mixed sentiment regarding expected trends in CMBS and CRE CLO demand/spreads, with 14 percent optimistic, 41 percent neutral, and 45 percent pessimistic. These figures align with the sentiment observed in the previous quarter.
Industry Sentiment: The overall sentiment for all CRE finance businesses remains cautious, with 67 percent expressing a negative outlook, 25 percent maintaining neutrality, and only 8 percent expressing a positive sentiment. Although the negative sentiment persisted, there was a slight improvement from the previous quarter. Sentiment for the industry peaked in 2Q 2021 when the survey found that 83 percent had a favorable outlook, with only 3 percent having an opposing view.
In addition to the index questions, the survey included two topical questions unrelated to the index, focusing on the Federal Reserve’s monetary policy and credit standards for CRE loans. Regarding the Fed’s terminal target rate by year-end 2023, 47 percent of respondents believed there would be no change, while 37 percent expected a 25 basis point increase. Eight percent anticipated a terminal target rate above the current range, and 8 percent predicted a rate below the current range. Looking at credit standards for CRE loans, 57 percent of respondents anticipated further tightening, 41 percent expected standards to remain steady, and 2 percent predicted some relaxation.
“The survey’s findings underscore the balance between improving sentiment and lingering concerns within the sector,” said Lisa Pendergast, executive director at CREFC. “As we continue to navigate economic uncertainties and evolving policy landscapes, the industry must remain resilient and adaptable to ensure long-term growth and stability. CREFC will continue to be a resource and advocate for the industry and its members during these uncertain market conditions.”
CREFC, with over 300 member companies and nearly 18,000 individuals, plays a critical role in the U.S. economy by financing various types of commercial and multifamily real estate, including office buildings, industrial properties, warehouses, retail facilities, hotels, and multifamily housing.
The CREFC BOG Sentiment Index aims to assess quarter-to-quarter shifts in market conditions for the CRE finance market and provide insights into the future outlook. The index equally weighs the responses to each question and aggregates them to create a single index value.
Source: Los Angeles Times, Business Insider
