What do low interest rate environments mean for CRE lenders?
I am interviewing with a few lenders in the CRE space currently. Many of them work with agencies, life companies, and banks. I’m curious, how does the current interest rate environment impact the terms of these offerings?
Thanks for your time and feedback.
To be completely honest, I'm not sure whether or not low interest rates would be helpful or harmful to lenders. It should mean more business and developments since the cost of borrowing is now cheaper. At the same time, the reason for cheaper debt is because of overall stagnation in the economy due to covid and decreased demand for new real estate developments, especially in office or retail since nobody's really looking to start a new business right now.
It has been a low rate environment for the last decade. It doesn’t change a whole lot for lenders because they institute floors/raise floors or start quoting coupons vs. spreads to get to the yields that they want.
The base rate going from 1.50 to .50 just means that your spread went up 100 bps to compensate.
The profitability of lending is the same whether it’s a low rate environment or high rate environment (for fixed rate lending). Floating rate has a few other nuances but mostly the same.
This is because lenders make money off the spread. So a bank does a loan at 4% - well they take the money from their deposits which they pay, for example, .5% on. So the bank makes 3.5%. Now let’s say it’s a high rate environment, the bank lends money at 8%. But this time, they pay their depositors 4.5%. The bank still only makes 3.5%. For lenders, it’s a cost of capital and spread game. If your spread erodes, so does your profitability. Spread can erode if lending spreads decrease (tighten, get lower) but you can’t lower the amount you pay depositors as quickly.
If you do the math, you’ll see banking can be extremely lucrative. Even if banks only make 2% spread, but you have a $50BB book of business, do the math. Now, not all banks have a book that large, but you get the point. The hard part about lending is consistently finding strong opportunities to lend on. Unlike, you don’t own something in perpetuity. So if your average loan is 5 years, every year you have loans paying off, which is amazing. But now you need to find a new home for your capital.
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