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Not Everyone In CRE Was Ready For The Fed To Raise Rates

The Federal Open Market Committee officially raised its benchmark rate 50 basis points on Wednesday, a move that was every bit as expected two weeks ago as it was unexpected four months ago.

Federal Reserve Chair Jerome Powell speaks at a virtual press conference in March 2021.

The Federal Reserve has been forced to pivot its monetary policy to a much more aggressive stance in recent months, as inflation continues to outpace wage growth and Russia’s invasion of Ukraine has destabilized stock markets around the world. Now, debt is more expensive than it has been since the pandemic began and looks to only get pricier for the rest of the year — an unpleasant surprise for anyone who had planned on securing new loans or refinancing in the next 12 months.

“A lot of people were probably thinking they had some time before they had to worry about rates going up or before they had to think about a refinancing decision,” JLL Chief Economist Ryan Severino said.

At his press conference announcing the FOMC’s decision to raise interest rates and allow mortgage-backed securities to roll off the Federal Reserve’s balance sheet for the next few months, Fed Chair Jerome Powell expressed his expectation that 50-basis point hikes will also be the outcome of the next two FOMC meetings. The Fed hasn’t raised interest rates by 50 basis points at a time even once since 2000.

The availability of cheap debt was one of the driving factors behind 2021 being a record-setting year for commercial real estate transactions, as it bolstered the levels of dry powder from private equity investors that have been at unprecedented levels for well over a year now. The extreme competition for assets drove prices for popular property types like multifamily and industrial so high, even some who made purchases early this year acknowledge overpaying, multiple sources told Bisnow.

In justifying the Fed’s hawkish turn, Powell cited two “negative shocks” to the supply side of the economy: the length and intensity of Russia’s attack on Ukraine has far exceeded the financial markets’ expectations from the beginning of the year, and China continues to pursue a “Zero Covid” policy that has caused lockdowns of entire ports and factories at a moment’s notice.


“Price stability is perhaps the most fundamental thing we're here for, and the way we do that is we try to get supply and demand back in balance,'' Powell said. “Now the process of getting there involves higher mortgage rates and higher borrowing rates. So it's not going to be pleasant either. But in the end, everyone is better off, particularly people on fixed and lower incomes.”

The demand among real estate borrowers for new or refinanced loans has already begun to ebb. Price growth has slowed in the past few months in commercial real estate, but it has yet to retreat back to valuations in line with what lenders can support at last year's capitalization rates, Nuveen Real Estate Finance Managing Director Jason Hernandez told Bisnow.

"Over the last two months, you've seen leverage levels come down," Hernandez said. "So as a lender, I'll effectively assume you're overpaying for the asset and I'll give you 65% leverage instead of 70% or 75%, because I like the basis there." 

Anecdotally, several investors who agreed to purchase commercial properties two months ago have been forced to ask sellers to lower prices ahead of closing because they could not get the loan-to-value ratios they anticipated from lenders, Hernandez said. The fact that such an option is even considered is a reflection that competition for assets has cooled somewhat in the past two months.

“There are clearly fewer bids than there were 90 days ago,” Hernandez said.

That demand for loans and aggression in terms offered by lenders are on the retreat shows the Fed’s plan is already beginning to work. But the environment right now is particularly painful for those who made shorter-term bets in the past six months, such as with corporate debt.

"When the Treasury moves in a way you didn't anticipate, you could potentially get caught flat-footed," Severino said. "That will force some people to get creative."

JLL's Ryan Severino speaking at Bisnow's 2018 NYC Forecast event on Dec. 12, 2017.

Short-term financing deals made when markets were beginning to open back up in 2020 could be causing tough decisions between refinancing expensively, putting more equity into a property or selling earlier than anticipated, Walker & Dunlop Real Estate Finance Managing Director John Gilmore IV said.

“Any transaction that was done two years ago, three years ago and that is ready to be refinanced now into a long-term, fixed-rate product because it has achieved its business plan, in many cases owners are forced to sell those properties, because assumptions that were made when the debt was taken out have not played out,” Gilmore said.

Many borrowers whose loan terms allowed them to refinance in the past year took advantage, locking in rates at historic lows. Any property owner with floating-rate debt, however, will either be looking to sell now or hoping tenant demand can withstand the rent hikes they may need to undertake for operating income to keep up with debt service payments.

For floating-rate lenders who syndicate loans and sell them as securities, the Fed's recent policy shift has likely been the most damaging, with the commercial mortgage-backed securities market having "shut down" over the past couple of weeks, Hernandez said. If equity investing trails the debt markets by a few weeks like it traditionally has, then property valuations could start heading backward in the near future.

"A lot of the deals being done today are being priced based on 90 days ago," Hernandez said. "Those numbers are stale.”