Research Brief: Financial Markets-Federal Reserve Meeting

Softer Rate Hike Outlook Potentially Clears Some Hurdles for Investors

Excerpt of Full Report:

Banking shock prompts Fed to take a more measured approach. At its March 22 meeting, the Federal Open Market Committee raised the federal funds rate for the ninth time in 12 months. The 25-basis-point hike matches the margin from February and lifts the lending rate’s lower bound to 4.75 percent. The FOMC cited still-too-high inflation and a persistently tight labor market as reasons for necessitating the increase, which is nevertheless below what was anticipated by the market just a few weeks prior. The recent seizures of Silicon Valley Bank and Signature Bank, while due to unique challenges and quickly contained by regulators, have prompted more caution around the banking sector. The resulting tightening to credit conditions is likely to complement the Federal Reserve’s goal of reducing inflation and softening employment, allowing for a smaller policy rate adjustment.

Further rate hikes less likely. The combined 50-basis-point lift so far this year marks a much more deliberate pace from 2022, when the overnight lending rate was hiked by more than four times that amount in a similar span of time. Moving forward, the Fed is likely to be just as measured, if not more so. In order to take time to assess the full impact of the recent banking shock, the FOMC has walked back previous language indicating ongoing rate hikes and has instead advised that some policy firming may be necessary. A more stable federal funds rate will go a long way to aid commercial real estate lending, allowing capital providers to more readily set terms and determine valuations.

Clearer near-term rate picture to help investment landscape. A more consistent federal funds rate would give financiers and borrowers more time to agree on terms. While the bank closures will likely spur lender caution over the short-term, tightening underwriting, recent downward pressure on the 10-year Treasury together with reduced rate uncertainty could deliver modestly lower interest rates to commercial real estate borrowers. A net increase to capital costs over the past year will nevertheless require investors to take on less leverage going forward, but for well-performing properties, asset demand should supersede those concerns. Most property sectors are in strong long-term positions, even if some asset classes like downtown offices face headwinds.

Wave of distress still unlikely. The rapid rise of interest rates over the past year underscore concerns about distress among properties with upcoming debt maturities. Current distress is low, at about 1 percent of recent sales, well below the 20 percent peak following the Global Financial Crisis. Whether this trend will pick up going forward largely depends on property performance. Owners holding onto well-performing properties are unlikely to enter a distressed sale purely because of higher capital costs from refinancing. The situation could be different for under-performing assets, which may be more prevalent among urban-core office towers and outdated retail floor plans.

Commercial real estate not a risk factor for banks. Concern of commercial property distress extending to the banking sector is also unlikely. Chairman Powell stated that banks holding concentrations of CRE debt are not comparable to SVB. Much of the debt maturing in 2023 is backed by CMBS, while more bank debt is maturing after 2024 when the interest rate environment could look very different.

Banking Shock Ripples to Broader Capital Markets with Mixed Impacts

Lenders become slightly more conservative post-SVB collapse. Many banks have already adopted more caution over the past few quarters, and the recent fi nancial sector turmoil may further heighten due diligence. While the SVB and Signature Bank seizures were a consequence of unique circumstances, lenders across the industry will likely heavily scrutinize LTVs and take conservative underwriting and debt service coverage approaches. Reducing their risk profile may be paramount for depository institutions as regulators pay closer attention to balance sheets. Meanwhile, a fl ight-to-quality has pushed down interest rates on vehicles like treasury bills, but lenders have also widened their spreads. This combination should have a relatively negligible impact for borrowers

Commercial real estate borrowers face some extra hurdles. As many lenders tighten underwriting in response to the bank seizures and greater regulatory attention, commercial real estate borrowers may have some additional obstacles to combat. Interest rate increases over the past year have made debt service coverage tests a significant constraint on the amount of leverage available for refinancings and new loans. Many lenders will require borrowers to pay down some of their existing loan if they want to refi nance. Additionally, most banks will continue to focus on standing relationships rather than growing their books. This is partially due to liquidity constraints enforced by high short-term bond yields, as depositors shift funds to those instruments. These dynamics will sustain real estate transaction hurdles near term and keep buyer-seller expectations separated. Nevertheless, opportunities are still out there for investors who do not need a lot of leverage. Agency lenders like Fannie and Freddie may also serve as a good option for some borrowers, as they have ample liquidity and remain active.

Denver Office:

Adam Lewis Vice President, Regional Manager

Tel: (303) 328-2000 | adam.lewis@marcusmillichap.com

Prepared and Edited By:

Benjamin Kunde Research Analyst | Research Services

For Information on national multifamily trends, contact:

John Chang Senior Vice President, National Director | Research Services

Tel: (602) 707-9700 | john.chang@marcusmillichap.com

The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, express or implied, may be made as to the accuracy or reliability of the information contained herein. Note: Metro-level employment growth is calculated based on the last month of the quarter/year. Sales data includes transactions sold for $1 million or greater unless otherwise noted. This is not intended to be a forecast of future events and this is not a guaranty regarding a future event. This is not intended to provide specific investment advice and should not be considered as investment advice. Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; CoStar Group, Inc.; Real Capital Analytics; RealPage, Inc. © Marcus & Millichap 2021 | www.MarcusMillichap.com