Posted on November 27, 2022
It’s hard to have a conversation about real estate lately that doesn’t involve interest rates. While rates are nowhere near historic highs, the quick escalation from what has been over a decade of low rates has impacted almost every aspect of the industry. The focus of most media coverage on rate hikes has largely been around residential property— understandable since residential mortgages affect such a large portion of the population. But these higher rates are also impacting the commercial property market, albeit in different ways.
Loans for commercial properties are much more diverse than their residential counterparts, both in how they are structured and where they come from. While it is easy to track “average mortgage rates” across the country, no such thing exists in commercial financing because every loan is tailored to the details of the property, the needs of the borrower, and the preferences of the lender. This makes predicting what interest rate a commercial loan might carry much more difficult and is made even harder by the rapid changes seen in the last few months. “A loan comp from six months ago is worthless,” said Tim Milazzo, co-founder of the commercial financing marketplace StackSource. “In order to understand what kind of loan a property will qualify for, you have to shop it around and get feedback from the market in real-time.”
Traditionally, “shopping a loan around” meant going through loan brokers. But even the most well-connected loan broker usually relies on a stable of direct lender relationships. In the current environment, that might not be enough to find the right debt for certain properties. That is where marketplaces like StackSource come in. By connecting borrowers with lenders across the country, many more opportunities open for borrowers, especially when some lenders are pulling back.
Fortunately, the rising rates have not yet had a huge impact on the appetite of many lenders. “We have seen construction and bridge loans start to slow down since those are generally some of the riskiest loans, but stabilized properties and favored asset classes are still getting plenty of offers,” Milazzo said. The inflationary environment that caused the Fed to raise rates has also spurred lenders to get money into the market rather than letting it sit on their balance sheets. Banks are usually the cheapest option, but according to StackSource data, debt funds, which usually have a larger appetite for risk, are quickly approaching similar rates to those offered by banks.
In this morphing economy, not only are rates going up, but terms are changing as well. Some lenders are lowering their LTV in order to protect themselves from what they see as a possible value reduction. When Milazzo looks at which loans are getting funding through his platform, he can’t help but notice how important certain loan terms are right now. “I am surprised by the fact that fewer than half of the loans we facilitated were the lowest rate that was being offered,” he said. It seems that even with higher rates, many investors prefer loans with higher LTVs, less stringent prepayment penalties, or no clause for personal recourse. It turns out that many property investors right now are willing to pay higher rates in return for more leverage, preserving their cash for the next deal.
After the financial crisis of 2008, many people worried that a prolonged period of higher rates might cause commercial property values to fall so much that it could strain lenders. But this thinking might be misguided. With the exception of a few banks that focus specifically on commercial property lending, most banks have less than half their debt in commercial assets. This buffers many of them from the type of catastrophic loss that we saw with Lehman Brothers and Bear Stearns.
Everyone in real estate hopes that elevated interest rates are only temporary. If the Fed is able to control inflation as they hope, rates may fall as quickly as they rose. But even in a high-interest rate environment, there are plenty of lenders willing to lend on commercial properties, for now. And thanks to technology like lending marketplaces, borrowers have a much easier time finding the loans that best suit their needs.