If there’s one word to describe businesses and the overall economy over the last two years, it would be “resilient.” Despite uncertainties, U.S. economic growth was still strong in the first quarter. At the same time, the near certainty of higher interest rates calls for prudent planning in the commercial real estate sector. There is also the backdrop of the conflict between Russia and Ukraine and gas prices that remain significantly elevated.
Despite all this, the economy in March added 413,000 jobs and the unemployment rate dipped to 3.6%, a decline of 0.2%. This unique set of variables has contributed to a shift in the year’s commercial real estate finance outlook, according to Trepp’s April 2022 monthly report.
In February, the Mortgage Bankers Association (MBA) released a report on commercial and multifamily mortgage originations for the fourth quarter of 2021. The report pointed to the quarter as a record end to a record year of lending. MBA’s numbers demonstrated a 79% increase in originations year-over-year and a 44% increase over the previous quarter. Rebounding property fundamentals, record sale transaction volume and low interest rates were among reasons cited for the jump.
In April, however, MBA adjusted its commercial and multifamily lending forecasts for 2022, citing the shifting economic and interest rate outlook. MBA expectations are that commercial and multifamily lending will hold steady at a projected $895 billion in 2022, roughly in line with 2021’s $891 billion. Multifamily lending, which is included in these figures, is expected to dip to $418 billion this year, down from 2021’s estimated $470 billion. However, MBA still considers this multifamily expectation robust and anticipates borrow-ing and lending to grow in 2023 to nearly $950 billion of total commercial lending, with $442 billion in multifamily lending part of this total expectation. MBA notes that, even with rising interest rates likely to impact lending volumes this year, healthy property values and fundamentals should support the markets and maintain commercial real estate mortgage demand at strong levels.
“If the pandemic proved anything, it was that rental housing is essential,” said Ed Hussey, head of conventional agency lending at Sabal Capital Partners. “Lenders remain bullish on multifamily and are committed to financing it. Properties that serve the country’s workforce and lower-income earners remain top targets for lenders as demand continues to surge for these units amidst lackluster supply.”
Drilling down deeper, not all commercial as-set classes share the same finance outlook as multifamily. For example, the health of the office sector remains unpredictable. The “work-from-home” effects of the pandemic are yet to be fully realized. Many companies are using hybrid or fully remote models, downsizing or fully jettisoning their office space, Trepp reported. In February, MBA noted a 122% year-over-year increase in the dollar volume of office loans. As of April, the office sector encompassed 4,907 loans at a total balance of $197.66 billion, with urban offices comprising 71% or 2,592 loans at a $140.36 billion balance. Lenders today are evaluating office transactions based on lo-cations, both pre- and post-pandemic tenant stability, tenant creditworthiness and lease rolls during the loan terms.
In the retail sector, supply chain bottlenecks, a continued increase in online shopping and higher costs due to inflation are all areas to watch; however, COVID-19-related shutdowns no longer keep customers from entering stores. Per the MBA, retail delivered a year-over-year increase, from 2020 to 2021, of 109% in the dollar volume of loans. Likewise, Trepp’s Year-End 2021 report found annual retail property loan delinquency rates declined; however, it also noted a significant drop in CMBS loan activity, demonstrating that lenders remain cool and cautious on this sector.
Industrial real estate continues to shine. 2021 represented the second consecutive year that the North American industrial and logistics market reported record performance, attributed to strong economic growth, sizeable job gains and increased retail sales. To address the surge in online consumer activity, increase safety stock and limit the impact of supply chain disruptions, occupiers leased an unprecedented amount of space — a total of 450 million square feet. Annual rent growth hit 16%, and the direct vacancy rate was just 3.4%, according to CBRE’s 2022 North America Industrial Big Box Review & Outlook. Newer buildings with state-of-the-art systems continue to be the most sought-after proper-ties, though older product has also benefited from favorable market dynamics. The year-over-year increase in industrial loans by dollar volume was 113%, per the MBA. Today, lenders continue to favor industrial and distribution facility assets. Consequently, competition for loans is robust among portfolio and capital markets lenders alike.
Generally speaking, commercial and multi-family lending is expected to remain strong throughout the year despite inflation, interest rate hikes and other concerns. However, borrowers are likely to find that lenders are more enthusiastic to participate in transactions within asset classes demonstrating continued demand. Additionally, with rates increasing, borrowers have likely found they need to bring more equity to their deals.