What kind of incremental risk does an index pose to a commercial real estate investor who’s set to borrow?
That’s the question Thirty Capital CEO Rob Finlay posed to his team of market analysts at this morning’s CRE Capital Markets Report roundtable podcast.
Analyst Jay Saunders said: “If you have an option your lender is going to tell you what the index should be, or what the lender wants to use.
“To the extent that you have options, you really need to look at your plan of finance,” Jay continues. “If you are a hedging entity, SOFR is going to be a better index for you; BSBY is not.”
Jay pointed out that there isn’t any options market in BSBY. “So if you’re a floating rate borrower and you intend to buy a cap, you can’t buy a BSBY cap . . . keep that in mind, at least for the moment.”
Jay explained that pure cash borrowers not concerned about hedging need to understand the index they are offered. If you are an entity that chooses to hedge some amount of that exposure, then you really need to think about what the banks are offering you, because some of those indices may be either unhedged or are much more expensive to hedge than others.
CRE Borrowers Locking In For Six Months
Analyst Jeff Lee says that right now a lot of CRE investors are kicking the can down to Q1 of 2022 and locking in rates. This can potentially change an investor’s finance plan and because a jump in an index could make some deals go sideways.
Jeff says Thirty Capital is talking to a lot of clients about the operational band of where things make sense now versus where they might start not to make sense, even if they go out to six months to a year.
“I think the big thing is that the national average for multi-cap rates was down almost 50 basis points,” he noted. “So you’ve got this pocket right now of super-low cap rates.”
Jeff says commercial real estate borrowers need to try to know what their threshold is in terms of basis points and the Ten-year, vs cap rates coming back up a little bit.
The market is seeing a lot of issues at play right now, and investors need to know where their threshold and band are, and plan for it.
Floating rate borrowers are likely still comfortable through the end of 2022.
Keep An Eye On The CMBS Market
Rob believes the CMBS market will be really interesting because there are a lot of securitizations getting ready to price not just single borrower CMBS, but also multi-borrower in September.
“If they get good execution, that means that you can expect them to be fairly aggressive going forward, especially before the year-end,” observes Rob.
“We’re in the market right now for a deal and Freddy really wasn’t a player, but Fannie was. This was a multifamily deal that I own outside of Boston and Freddy wasn’t really aggressive on it. Fannie was.
“There’s lots of sources of capital out there, but it’ll be really interesting to see if the CMBS market can go,” adds Rob. “I know that CLS are also very aggressive right now and they have a great execution on the secondary market. So it’ll be really interesting to see if CMBS can unload all these bonds. They’re on track for a record-breaking year.”
Tapering Talk Continues
In this episode, the analyst also discusses tapering, which is rumored to begin in November.
Analyst Jason Kelley points out that tapering is on the long end of the curve. The Fed doesn’t want to make an inverted curve where short-term interest rates would be higher than long-term interest rates. They are still buying $120 billion of bonds a month now. They’re going to start really small.
“Cutting it from $120 billion to $110 billion or $100 billion . . . if it’s more than the market thinks, then there’s going to be a reaction in the market,” explains Jason.
“Once that long end of the curve starts going up, then they’ll start raising short-term interest rates. It’s gonna be a long process on the short end before rates rise.”
Wednesday will see GDP and PCE deflator announcements.
Analyst Bryan Kern points out that the market has been range-bound really since the middle of July, between Fibonacci retracement levels of 50% and 61.8% which, on the Ten-year yield, would be a 1.19 and 1.32.
Changes could depend on the next round of employment numbers, but Bryan adds that a two percent by year-end is certainly doable.
In other news, the FDA fully approved the Pfizer vaccine, and Jay notes that anything that increases vaccines and gets people back to the office is going to be good for the markets.
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