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With Debt Harder To Get, CRE Finance Is Facing A 'New Reality'

Commercial real estate lenders have responded to increased risk and higher costs of capital in the market by clamping down on the amount of debt they offer to borrowers, dropping loan-to-value ratios across the board, according to MSCI. 

CMBS providers reduced their LTVs the most of all lender types, cutting them by 14% to 55.7% from 2015 to 2023, while seeing average loan size more than double over the same period. Smaller amounts of debt available mean greater equity is needed to get deals done, opening a window of opportunity for some investors while shifting the CRE financing landscape, at least temporarily.


“The CMBS market and the origination shops are geared towards execution,” Polsinelli shareholder John Vavas said. “The only way to do that right is to offer a lower-leverage deal. Higher interest rates, higher carrying costs, all equates to an increase in the need for equity for deals.”

Average loan sizes for CMBS lenders reached nearly $22M in 2023, up from $17.6M in 2022 and $10M in 2015. Part of the reason is a smaller number of deals, skewing the average, but there has also been a shift among CMBS lenders over the last five years, according to MSCI’s U.S. Capital Trends Report.

CMBS lenders started lowering their LTVs before the current credit crunch and even before the pandemic, though the dropoff became significantly steeper in 2022 as interest rate hikes kicked in, MSCI data shows.

Tightening lending standards in down economies is common, and lending institutions typically loosen back up when things improve. But this time around, there’s the question of the long-term financial health of the properties themselves. 

“The fear has been of an adjustment as interest rates and mortgage rates go higher, where property prices can be challenged,” MSCI Research Executive Director Jim Costello said. “So in the near term, there's lower LTV to compensate for that risk.”

Eventually, as interest and mortgage rates hold steady for a longer period, that fear will go away, Costello said. But there are other reasons why lenders could remain conservative, Costello said.

“At that stage, it would be about income,” Costello said. “If income starts faltering at the property level, that can make lenders fearful and keep LTVs low for a long time.”

And in that case, there could be changes around how real estate is viewed as an investment vehicle, he said.

“To have LTVs stay at a low level for the long term would mean a permanent shift of investor perceptions of risk around real estate,” Costello said.


Whether short- or long-term, the increased need for equity to finance CRE deals offers opportunity for investors on that end of the capital stack, Vavas said.

“When a borrower is faced with paying interest rates that, given the current interest rate climate, are akin to the cost of equity, the similarity in cost of capital pushes borrowers to infuse more equity from new partners as opposed to incurring additional debt at such high rates,” he said.

But Vavas and others expect that as interest rates come down, leverage will head back up again, closer to its position before the pandemic or in 2021 before interest rate hikes.

“I don't think it's permanent,” Cresset Partners’ Head of Real Estate Capital Markets Elizabeth Wohlleb said. “It reflects today what lenders can do and how far they can go. It's always been like that, and it's happened multiple times in my 26 years in real estate.”

Costello agreed, stressing that a world in which lower leverage becomes semi-permanent is far from certain. 

“Just because it’s low today doesn’t mean it stays low forever,” he said. There’s a temporary period where the market is trying to figure out, ‘What does it mean that we’re not seeing support from the Fed the way that we have since 2009 and the Global Financial Crisis?’” 

But lenders, and borrowers, do have to acclimate to a new normal, he said.

“The market is waking up and adjusting to a new reality. You’ve got more than a decade of effectively free money, and the market is waking up to the reality that that has changed. You take away more than a decade worth of support and people don’t react to that news overnight. So the market’s moving slowly and figuring out where it’s headed.”