Q2 Debt Market Overview

The arti­cle rep­re­sents sub­jec­tive opin­ions of Hines Inter­est Lim­it­ed Part­ner­ship (“Hines”¹), the spon­sor of invest­ment vehi­cles offered by Hines Pri­vate Wealth Solu­tions LLC (“Hines Pri­vate Wealth Solu­tions”). Oth­er mar­ket par­tic­i­pants may rea­son­ably have dif­fer­ing opinions.

Capital Conundrum

Even though the top­ic has fall­en from the front page, there is no short­age of news sound­ing the alarm over the health of region­al banks. Since March 2020, the entire bank­ing indus­try has faced a num­ber of stres­sors (see the graph­ic below) – being forced to adjust to rapid rate hikes, new reserve require­ments, and reduced liquidity.

SOFR Rate Source: https://​www​.newyork​fed​.org/​m​a​r​k​e​t​s​/​r​e​f​e​r​e​n​c​e​-​r​a​t​e​s​/sofr

In some cas­es, these pres­sures led to fail­ures of under-cap­i­tal­ized insti­tu­tions (like Sil­i­con Val­ley Bank), but these con­di­tions have also result­ed in low­er cred­it avail­abil­i­ty. This obvi­ous­ly is a prob­lem for com­mer­cial real estate bor­row­ers need­ing funds or fac­ing short-term maturities.

Obtain­ing invest­ment financ­ing is much more dif­fi­cult and prici­er as of July 2023 than 18 months ago, but Hines remains opti­mistic that fund­ing is still avail­able from a vari­ety of lender types for strong deals with strong sponsors.

U.S. Financing Conditions

Austin Drake, who leads debt financ­ing at Hines, says ​“U.S. debt cap­i­tal is avail­able but the mix of providers (and offer­ing terms) has changed con­sid­er­ably” (see his sum­ma­ry below). Over­ar­ch­ing themes include high­er inter­est rate spreads, low­er lever­age, and more structure.

• Banks have been focused on reduc­ing loan com­mit­ments and shoring up depos­i­to­ry bases. As a result, new loan orig­i­na­tion has become mut­ed. Expo­sure to under­per­form­ing loans has banks focused on asset man­age­ment and help­ing trou­bled bor­row­ers remain current.
• Life insur­ance com­pa­nies are aggres­sive­ly pur­su­ing term financ­ing for pre­ferred asset class­es, includ­ing indus­tri­al, mul­ti­fam­i­ly, and retail. They have pro­vid­ed more pre­pay flex­i­bil­i­ty and float­ing rate options for both term and con­struc­tion loans.
• Due to their char­ters, gov­ern­ment-spon­sored enter­pris­es (“GSEs”) have remained a reli­able source of liq­uid­i­ty for mul­ti­fam­i­ly prod­uct. With year-to-date vol­umes down, the GSEs have been enter­tain­ing mar­ket-rate trans­ac­tions, but remain com­mit­ted to ​“mis­sion dri­ven” assets, i.e. ​“green” and afford­able hous­ing. Fixed and float­ing-rate options are available.
• Debt funds have had sig­nif­i­cant cap­i­tal avail­able for all types of loan struc­tures, but at ele­vat­ed rates. Hines believes debt funds are best suit­ed for larg­er bridge and con­struc­tion loans.

• Con­duits (loans secured by mort­gages on com­mer­cial prop­er­ties) are often bun­dled into com­mer­cial mort­gage-backed secu­ri­ties (“CMBS”). Drake not­ed that this vol­ume dropped about 80% year-over-year, and no sin­gle asset, sin­gle bor­row­er (“SASB”) trans­ac­tions have been orig­i­nat­ed in over a year. Investor demand and pric­ing has con­tin­ued to swing with broad­er volal­i­ty in the Trea­sury and cor­po­rate bond markets.

Rate Conditions in Europe

The inter­est rate pic­ture is some­what dif­fer­ent across the Atlantic. The Euro­pean Cen­tral Bank (ECB) raised its bench­mark rate to 3.75% in late July. Ian Brown, senior man­ag­ing direc­tor for Hines U.K., not­ed that while this is the high­est in 22 years, it is still sig­nif­i­cant­ly below U.S. and U.K. lev­els. Mar­kets expect­ed the July hike, but Brown observed that this might be the last in the region, as the for­ward three-month Euri­bor² curve cur­rent­ly peaks around 4% before slow­ly falling in 2024 (see graph­ic above). The out­look in the U.K. accord­ing to the for­ward curve is for con­tin­ued rate increas­es (includ­ing the 50 basis point hike on June 22, 2023), with its coun­ter­part rate peak­ing close to 6% in late 2024 (see next graph­ic). Inter­est­ing­ly, inter­est rate expec­ta­tions in Europe haven’t changed much since April 2023, although in the U.K., expec­ta­tions have jumped almost 100 basis points over the same peri­od, pos­si­bly imply­ing that investors feel the infla­tion bat­tle has not yet been won.

About Liquidity

Brown reports that in gen­er­al, Hines believes that there is good liq­uid­i­ty in Europe for strong spon­sors and projects. The liv­ing and logis­tics sec­tors have been par­tic­u­lar­ly well bid, with grow­ing inter­est being seen in life sci­ence, self-stor­age, retail parks, and hos­pi­tal­i­ty projects. Sim­i­lar to the U.S., there are a con­sid­er­able num­ber of alter­na­tive Euro­pean lenders that may help to fill the gap.

Office financ­ing has become more dif­fi­cult, and is increas­ing­ly focused on the newest, most mod­ern projects. Liq­uid­i­ty for val­ue add and devel­op­ment financ­ing is more like­ly to orig­i­nate from debt funds and insur­ers. Large deals requir­ing syn­di­ca­tion have become more expen­sive, in part because not all fund­ing sources are active, and region­al banks are not always will­ing or able to participate.

Brown also not­ed that the increased cost of debt (around 7% in late June 2023) is mak­ing lever­age in the U.K. much less attrac­tive. In addi­tion, senior³ loan-to-val­ues now do not often exceed 55%, with banks remain­ing more con­ser­v­a­tive to ensure accept­able inter­est cov­er­age. Refi­nanc­ing gaps have become com­mon, but so far, banks have been will­ing to work with cur­rent borrowers.

Capital is Still Available, But…

While Hines project fund­ing is still avail­able, the math is quite dif­fer­ent com­pared to 18 months ago. Rates are up dra­mat­i­cal­ly (as is the cost of hedg­ing, impor­tant for cross-bor­der investors), which impacts the abil­i­ty of devel­op­ers to hit return tar­gets. If for­ward curves are cor­rect, it appears Europe may be first to cease inter­est rate hikes with its bench­mark rate pro­ject­ed to peak dur­ing the sum­mer of 2023. The US may not be far behind, giv­en the good news on infla­tion report­ed for June. We believe all of this bodes well for large, expe­ri­enced invest­ment man­agers with the resources and access to cap­i­tal who can use it judi­cious­ly to take advan­tage of dis­tressed oppor­tu­ni­ties globally.

Pub­lished August 2023.