NEW YORK–A new report offers some insights into what a flattening yield curve, short-term rate increases and slower upticks in longer-term yields mean for the commercial real estate industry.
The report, published by Trepp, examined the future for commercial mortgage-backed securities (CMBS) loans, which are most often priced off of the 10-year swap, which in turn is a spread to the 10-year Treasury rate.
“The simple answer is that loan rates are going up,” the analysis notes. “A more complicated answer is that loan spreads have generally averaged about 150 basis points when the 10-year was above 4% and around 250 basis points when the 10-year was below 4%. If we assume the 10-year gets back to 4% in the next year or so and that loan spreads end up around 200 basis points, average CRE loan rates should climb to 6%. Loans originated now at 4.5-5% rates would be worth about 7-10% less (using a simple assumption of 7-10 years in average duration).”
The Upside
The Trepp analysis further notes lending standards since the recession have been much more conservative, meaning average DSCRs are relatively high.
“The upside to this is that performing properties should be able cover higher debt service payments,” according to the report. “However, if the conservative DSCR lending requirements remain in place, borrowers may have to bring more equity to the transaction or settle for lower proceeds in order to maintain the coverage ratios. “
The Trepp report also forecasts that cap rates will also be under the microscope as interest rates increase over the next year.
“If …our hypothesis regarding loan rates holds true (namely that average loan rates should head back to the 6+% area), it holds that cap rates should increase in a similar fashion,” the Trepp report states. “
Looking Forward
Looking Forward, Trepp said “bridge, transitional, mezzanine, and other higher yielding CRE finance lenders should see increased opportunity in the rising rate environment as borrowers look for help bridging the gap from old lower rate financing to new loans with higher costs and longer terms. Although most first-lien debt in CMBS carries relatively low leverage (55-60%), there should still be increased opportunities for well-capitalized equity investors to acquire properties on the DSCR margin that may be underwater in the new higher rate environment.”