I'd like to better understand what is going on with spreads in the CRE debt markets currently (I understand this is pretty broad) and if I am thinking about things correctly.
Here is how I think about spreads in a rising rate environment:
- Risk-free rates are rising, putting pressure on values, increasing recession risks
- Spreads represent a risk premium, therefore, in an environment of increasing risk, spreads should widen
Is the above thought process correct? And are spreads currently expanding in reality?
You are thinking about it correctly from a theoretical standpoint. However, the reality of the situation is that during time periods where we enter the downslope of the cycle due to rising rates (I.e. like the 80's):
(I) there is a period of price discovery (I.e. right now) given that base rates are significantly higher than at the beginning of the year;
(II) lenders who are in the market still need to lend, so they will initially compress their spreads due to increased competition for deal flow and in an effort to reduce rates (this is where we are right now for certain property types);
(III) eventually, once there true distress (eroding fundamentals, forced selling, etc) spreads will widen and eventually lenders could just stop lending… (I.e. right now balance sheet banks are not competitive due to spreads).
In my product type, so far in this cycle I have seen (I) an initial compression in spreads (given the attractive nature of my product type and v low deals available), (II) that the money center banks were the first to step back and increase spreads while regional lenders and insurance companies continued to compress spreads and remain competitive, (III) now I can still get attractive spreads but primarily just through relationships. We will see what happens next, but to give a sense for the numbers, at the beginning of the year most of my fixed rate debt was Index + 175-225 (high 3's to mid 4's, depending on the month) and today it's + 150-200. LTVs have also compressed to hit DSCR requirements.
This is not the story for office… where you can barely get a loan these days.
Really helpful answer. Appreciate your insights.
Is this for multifamily?
Existing, value-add infill self storage in primary (and some secondary) markets.
You’re getting 150-200 spreads fixed? 5 year CMT / fixed? Any years of IO? 30 years amortization? 1.25 DCR?
Seems really competitive.
5yr CMT generally yes, 10 year money, for primary markets 5-7 year firm term with 2-3 of IO and 30yr am, for secondary markets it's 5 year firm term with 2 yrs IO and 25yr am. These are just coming from our relationship lenders these days, earlier in the year we could get more proceeds and maybe a year more of IO. All else being equal, my spreads have compressed ~20-25 bps.
While my product type is niche, if you look at CBRE’s latest Q3 lending survey, spreads are still 20 bps tighter (for multifamily) than a year ago, increased in Q1 and were pretty much flat Q2-Q3. In hindsight, this might be a better industry barometer.
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