Lenders Appetite for Commercial Property Debt Dwindles

Commercial property activity has declined substantially this year, but it isn’t for lack of demand. Cash equity seeking commercial property deals is at an all-time high, according to data from Reonomy. At the close of 2019, there was $147 billion in cash equity available for commercial property acquisitions, and in the first half of 2020, nearly $24 billion had been raised. However, lender appetite for commercial property debt has dwindled, and the lack of debt financing had impacted commercial property investment.

This year, dollar volume for commercial property has decreased by 46% year-over-year through July 2020, and deal volume has decreased 37%, despite the availability of cash equity, Reonomy reports. Hospitality had the biggest decrease in deal volume, but all assets classes saw a significant decrease. In addition lenders’ lack of appetite for commercial assets has impacted price discovery, further deterring transaction volumes. This may trend may continue to negatively impact transaction activity for several quarters.

While lending activity has slowed for commercial properties, corporate borrowers have continued to secure more debt. The low interest rate environment—designed to fuel lending activity—has encouraged corporate borrowers. According to SIFMA, corporate debt issuances increased 80% in the first half of the year compared the first half of 2019. Although corporate debt issuances are increasing, lenders are more focused on credit in today’s lending environment. As a result, high yield issuances have increased less than half as much as investment-grade issuances. On the other hand, CMBS issuances have decreased by 25% through the first half of the year, according to Reonomy. This illustrates the decreased appetite for commercial properties.

Across the board for both corporate borrowers and commercial properties, lenders have tightened underwriting standards. For commercial property loans, lenders are cautious on construction deals and all asset classes, with the exception of multifamily. Lenders are taking a more conservative approach to these commercial property loans then corporate loans. As the pandemic has progressed, lending has only continued to tighten, and there will likely be greater constraints on underwriting.

Uncertainty is the primary factor diminishing lender appetite. While there have been past recessions and market uncertainty, most lenders have not navigated a pandemic-driven recovery. As a result, most lenders are more focused on the risk management of current loan portfolios rather than on originations. The performance of bank balance sheet loans has deteriorated during the pandemic; however, bank loan books are in better shape through this dislocation than in the 2008 financial crisis. Again, we are at the beginning of this event, and the Reonomy report predicts that delinquency, non-performing and chargeoff rates will increase over the next several quarters.

There are a number of implications one can draw from these findings, Reonomy concludes.

“The fact that lenders are tightening standards suggests that if you are looking to refinance or secure debt financing for a property, property operating and performance history is likely more important than ever,” it says.

Expect to see lower LTV’s, higher DSCR’s, fewer exceptions granted, more conditions, and overall less borrower flexibility.