Commercial real estate owners and project sponsors have spent the last three years navigating a perfect storm that started when the coronavirus shook up the economy and then intensified when interest rates began to rise more than a year ago.

At a time when some economic indicators seem to warn that a recession is imminent, it is no wonder that many are seeking sanctuary in a calm port until the storm blows over.

For many CRE owners, particularly in the office sector, that port can take the form of fixed-rate loans.

“Financing in office right now is tough in general unless you have a very strong rent roll, a strong market and an ability to bring equity to the table,” said Jake Proctor, senior vice president at KeyBank Real Estate Capital.

Unfortunately, office owners in many cities do not have those advantages, and they might find that the floating-rate debt they signed up for a couple of years back no longer makes sense in an era of rising interest rates.

“We're still seeing rent growth in some asset classes, but it's certainly moderating as this cycle ends,” Proctor said. “That is why financing on a fixed-rate, stabilized basis makes a lot of sense today when looking at increasing borrowing costs in the floating-rate market.”

Samantha Miller, vice president of multifamily mortgage banking at KeyBank, said a dramatic increase in the Secured Overnight Financing Rate over the past 12 to 24 months has changed how borrowers view their debt repayment. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities.

Not long ago, SOFR was “basically near zero,” Miller said. Today, it hovers around 5%.

“The floating pay rate now is going to be much more substantial compared to fixed-rate,” she said. “Also, the majority of floating-rate debt requires some sort of third-party cap and those cap costs and escrows have really increased as well. The combination of those two factors means that every deal we're looking at now is on a fixed-rate basis.”

Fixed does not mean inflexible, however, which also increases its appeal to borrowers.

Miller noted that many lenders are allowing for shorter-term fixed-rate terms of three or five years, giving the borrower a flexibility they may have previously experienced only with floating rates. Also benefiting borrowers are fixed-rate loans paired with flexible prepayment options.

“I think the switch away from floating rates, because of all the high costs and everything we saw with the SOFR forward curve, is also driven by creative fixed-rate options that offer flexible prepayment and shorter terms,” Miller said. “All of that gives more options to borrowers who want flexibility.”

Refinancing to a fixed rate might require an influx of cash, and many borrowers are turning to preferred equity, where there is a “ton of capital sitting on the sidelines and ready to go,” Miller said. That can be a lifeline to property owners caught in the vise between rising interest rates and stagnating or declining rents.

In one recent case, KeyBank recommended preferred equity to help a client fill a cash gap that arose when they needed to refinance at a fixed rate.

“We went out to 15 different preferred equity providers, and were able to find creative terms that matched what the borrower needed,” Miller said. “They had been thinking about preferred but weren't totally sold on the idea. So we showed them what it looks like today, and I think they were overall happy with the execution and are now considering moving forward with those preferred terms.”

It is hard to find a perfect finance solution in the current environment, Proctor said. However, he urged borrowers to begin exploring their options now.

“Working with lenders far in advance of upcoming maturities or early in the bid process is going to be the most beneficial thing,” he said. “Closing deals in 45 days was commonplace,  but certainly everything takes a little bit longer right now, and that's following a long quoting process where multiple leverage and loan term iterations are explored.”

Miller said that this sort of foresight is important as 2023 is likely to continue to be a challenging year, meaning borrowers will continue to prefer the port in a storm that fixed-rate loans represent.

“I do think there'll be pockets of opportunity this year, whether it’s someone needing to sell and you're able to buy the property at a really strong cap rate or, on the debt side, if lenders’ appetites begin to shift,” she said. “I think there'll be a lot of opportunities for strong financing, but it’s a matter of waiting and being ready to move once conditions begin to improve.”

This article was produced in collaboration between KeyBank and Studio B. Bisnow news staff was not involved in the production of this content.

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