Discussions about debt have become largely up-and-down discussions. Things are better or, more often these days, things are worse. That binary treatment though is inadequate, making planning and strategy blunt instruments.
A recent MSCI capital trends report broke down aspects of debt into observations that help explain what is happening in the markets.
First, borrowing costs for funds continue to rise. That should be fairly obvious because all borrowing costs are increasing. “With rising interest rates and higher costs for new debt, the borrowing costs on outstanding asset-level debt for funds in the MSCI/PREA U.S. AFOE Quarterly Property Fund Index have been increasing,” they wrote. “The rate reached 4.7% at the end of the second quarter, the highest level since 2012.”
As a comparison, MSCI said that commercial mortgage and apartment originations had sub-4% rates in 2020 and 2021. Now the rates respectively are 6.8% and 5.5%.
Another dynamic is the decrease of capital flows to CRE from the manic heights of 2021 and 2022. In the first half of 2022, the amount of capital going to CRE was $1,047.2 billion. In the first half of 2023, that fell to $643.3 billion. Construction activity fell only 17% year over year, the least reduction.
“The value tied to refinancing activity stood at $284.3b for the first half of 2023, a figure down 32% from a year earlier,” the report said. “Activity here is still elevated relative to the five years before the pandemic, when the value of assets being refinanced averaged $228.6b across each first half period.”
Something else that might seem fairly obvious is that the total number of lenders fell from the second quarter of 2022 to the same period in 2023. “The number of active lenders in the market can help determine the cost of debt capital through the process of competition,” they wrote. “If a potential borrower can shop around for financing from 10 different lenders, for example, they will get a better deal than if only two lenders are willing to be active in the market.”
The biggest fall was for suburban offices, with a full third having stopped lending. The fall for central business district offices was 30%. But even so, CBD offices faced a worse end result. The result for suburban offices was a reversion to 2017 levels, but CBD offices found themselves in 2015.
As debt availability has waned, seller financing has expanded. In the first half of 2022, seller financing was 0.5% of all originations. In the first half of 2023, that jumped to 1.9%. Drawing an ultimate conclusion, though, is hard, as the amount of lending has dropped. Perhaps to some degree, the seller financing was a larger percentage because the overall number contracted.