Rising interest rates, concerns about cycle end contributed to a 7 percent year-over-year decline in commercial mortgage originations in the third quarter.
As commercial and multifamily originations appear likely to close out the year roughly on par with the record activity of 2017, capital markets experts are reading the tea leaves for 2019.
The Mortgage Bankers Association (MBA) reported a 7 percent year-over-year decline in commercial/multifamily lending activity in the third quarter, based on its quarterly survey results, but predicts commercial and multifamily mortgage originations to total $532 billion for 2018, similar to last year’s record volume of $530 billion.
For 2019, the MBA forecasts total commercial/multifamily originations of $541 billion, a 2 percent increase over 2018.
Capital should keep flowing next year, according to Jim Cope, head of production for capital markets at Walker & Dunlop, a commercial real estate services and finance firm. “As long as interest rates don’t get out of control, capital flows will continue to be strong in 2019,” Cope says. Bethesda, Md-based Walker & Dunlop was the nation’s 10th largest commercial real estate lender during the first half of 2018, according to data from Real Capital Analytics (RCA), a New York City-based research firm. “We are not hearing that anybody is pulling back in allocations for 2019,” Cope notes.
Fewer refinancings may have driven the decline in third quarter origination activity, according to Christopher Moyer, managing director with the equity, debt and structured finance team in the New York office of real estate services firm Cushman & Wakefield.
“Over the last two or three years, as interest rates were lower, you had a lot of people that had maturities two or three years out and they were pro-actively refinancing to lock in low interest rates,” Moyer says. “As interest rates have gone up, we don’t have people proactively doing that.”
The Federal Reserve has raised its benchmark federal funds rate eight times since late 2015 and has signaled its intention to raise rates again when the Federal Open Market Committee (FOMC) meets on Dec. 19. More rate hikes are expected next year, although there’s been more talk lately that the Fed could ease off by mid-2019.
Dealing with uncertainty
The third quarter origination decline is not due to a pullback by lenders, but is rather an issue of investor demand, according to Tom Fish, managing director and co-lead of JLL’s debt practice in Houston. He notes that interest rate increases may have caused a slowdown in deals as fewer of them are penciling out the way they did earlier in the cycle.
“We’ve seen an uptick in rates; we haven’t seen a corresponding change in cap rates, so debt service coverages are tighter, resulting in leverage levels being cut,” Fish notes. “That probably manifests itself in an overall slowdown in volume.”
Sellers are becoming more reluctant to sell because they view redeploying of the capital to be potentially challenging at this point in the real estate cycle, Fish adds. Buyers, meanwhile, are being more cautious because of rising interest rates and because there’s more fear about when the cycle will end.
“I don’t think the lenders are slowing down; I think the lenders are as hungry as ever, but I think the transaction activity and the abilities for deals to pencil have slowed,” Fish says.
Multifamily, industrial and niche assets attract attention
Property sectors such as affordable housing, seniors housing, student housing and self-storage are among those that could gain more attention in 2019 as investors seek the best opportunities for strong returns.
“There will be opportunity in affordable housing because we just don’t have enough of it, and I don’t see any end to that,” Fish says.
On the agency side, the Federal Housing Finance Agency (FHFA), the regulator of Fannie Mae and Freddie Mac, recently set a 2019 multifamily lending cap of $53 billion for each entity, the same amount as in 2018. The GSEs will continue to be major players in the affordable multifamily sector.
At the end of October, Fannie Mae had provided $50.2 billion in multifamily financing, down from $51.1 billion from the same period in 2017, but up on a monthly basis when the month of January is excluded from the comparison, according to Phyllis Klein, vice president for multifamily customer engagement and marketing.
“In January 2017, we did over $9 billion, a lot of which was rollover from 2016; I view our 2018 levels as pretty much the same, if not better (than 2017),” Klein says.
Of all commercial property types, multifamily originations will finish 2018 with the biggest increase—up about 7 percent to $251 billion, according to MBA forecasting, with total multifamily lending at $302 billion. The multifamily sector is expected to cool down in 2019, with originations rising by about 2 percent, the MBA predicts.
Fannie Mae will continue its focus on providing debt and equity in the affordable housing sector, according to Klein, which will include low-income housing tax credits (LIHTC), a market the agency re-entered in 2018 with an initial focus on Hurricane Harvey-impacted areas, Native American housing and rural markets. Fannie Mae closed on a $100 million LIHTC fund in February 2018.
Retail and hospitality assets are typically viewed as more risky, so investors may be more cautious in those sectors next year, but there have been some retail assets this year that have traded at good cap rates and select opportunities could present themselves in 2019, according to JLL’s Fish. Office market fundamentals have been relatively flat, so optimism there is tempered, while multifamily and industrial sectors still show plenty of opportunities.
While there’s plenty of discussion about how long this cycle will last, there are also people who aren’t overly worried.
“I don’t feel like we are getting long in the cycle,” C&W’s Moyer says. Instead, he predicts a reduction in real estate investor expectations on levered and un-levered returns as the economy moderates.
On the other hand, Robert Dye, chief economist with Dallas-based Comerica Bank, says that economic headwinds will require a response from the commercial real estate industry.
Besides rising interest rates, those headwinds include higher wages from a tight labor market, tariffs and the prospect of reduced federal spending.
“It looks like headwinds are developing, and I expect to see cooler growth going forward. I expect commercial real estate developers to be aware of that and to start scaling back their projects.” Dye says he expects “a little bit cooler growth in 2019 and cooler still in 2020.”
While the MBA’s survey showing an origination decline in the third quarter isn’t a surprise, it is a cautionary signal, he notes.
“It’s appropriate to be cautious about the market right now, given current conditions.”