Competition Soars in Debt Markets As Capital Availability Remains at Record Highs

This year, competition has been soaring in the debt markets. There continues to be an abundance of capital in the market, and lenders are fighting to place debt. As a result, lenders are also looking to show restraint and discipline despite the increase in competition. Debt funds in particular have driven the current market dynamics.

“One of the factors that gave rise to the increase in debt capital availability is the proliferation of debt funds that began with the fallout from Dodd-Frank regulations encumbering banking institutions, including HVCRE increased capital requirements for construction loans,” Loryn Arkow of Stroock & Stroock tells GlobeSt.com. “These restrictions resulted in banks concentrating on their more price-competitive, less risky lines of real estate lending, creating a market opening for debt funds in construction and bridge lending and in meeting the demand for higher leverage loans.”

These opportunities have been popular among investors, particularly those looking for more stable returns. “Investors financing the debt funds could obtain their optimal balance of risk and reward in these vehicles where the investments provide for higher yield but are less risky than equity ownership of real estate,” says Arkow. “From a legal perspective, debt—versus equity—provides for a more certain cash flow stream with a finite maturity in addition to well-defined legal remedies while limiting exposure to ownership risks, such as environmental liability.  Also, many foreign investors are attracted to the risk profile of U.S. real estate debt and the comparative yields compared to debt markets overseas.”

Multifamily, industrial and office assets have been a favorite among debt sources. “Recent years have seen steady demand for the multi-family and office sectors, and the industrial and logistics sectors remain hot,” says Arkow. “The uncertainties and structural changes in the retail industry have made retail a less favored class, although we are seeing a significant amount of mixed-use projects with ground floor retail.  The hotel sector is taking a hit from the coronavirus outbreak and its impact to the travel industry.”

With the high competition comes a concern that lenders will loosen underwriting standards, akin to the practices that preceded the financial crisis. However, those concerns may be unwarranted. “The lessons of 2008 have not been lost on real estate lenders,” says Arkow. “Despite competitive markets, lenders have exercised discipline in their transactions. We certainly don’t see the high levels of leverage that were prevalent pre-recession. While lenders are aggressively competing for deals, those that are willing to compromise their underwriting standards are outliers.”