By Jim Costello on September 19th, 2019
The U.S. commercial mortgage market is as competitive as ever, the latest Real Capital Analytics review of lender composition shows. Debt funds have continued to gain market share and for the first half of 2019 represented a larger share of the commercial mortgage markets than the life insurance companies.
Coming out of the Global Financial Crisis, life company lenders were, for a time, the only game in town for many commercial property investors. The agency lenders did provide debt liquidity for the apartment sector, but for all other property types sourcing debt was nearly impossible unless one had maintained a long-standing relationship with the life company lenders.
It is disconcerting to many people that debt funds, a class of non-bank lenders, have overtaken a traditional source of lending that was so important in the aftermath of the GFC. In conversations with investor and regulator clients, I have heard fears expressed that these funds (shown in RCA’s Financial/Fund category) are going to load up the financial system with risks just like the CMBS originators did in ’03-’07.
The debt funds are not taking on the same sort of risks of the CMBS originators in the last cycle: these groups are taking on new types of risks. Importantly, these debt funds have skin in the game that the CMBS market did not in the last cycle.
Life insurance companies still represent a larger share of lending for core investment strategies than do debt funds, but the levels are close: a 10% share for life companies vs. 9% for debt funds. Into the riskier investment styles, however, debt funds captured more market share than insurance company lenders in the first half of 2019. Still, the debt markets remain intensely competitive with most categories of lenders capturing at least a 10% share of lending activity.
The competition in the debt markets has provided an important element of support for pricing over a time of growing uncertainty. A year ago, the 10yr US Treasury yield was climbing rapidly and investors were nervous; this year, the 10yr UST has been testing previous lows and investors have been nervous. Despite all the jitters, the RCA CPPI continues to climb.
Rather than test the waters in the sale of an asset, investors can refinance assets in the current market. Indeed, tracking total capital flows to commercial real estate, the value of refinancings represented 42% of the capital flowing to commercial real estate in the first half of 2019 versus a 38% share for the acquisition of assets. The remainder represents the capital flowing to construction opportunities.
Competition in the lending markets is clearly good for borrowers, but how much is too much is a good question. To date, lending standards in the form of LTVs seem healthy, but there is evidence that these figures are creeping higher.
The new edition of US Capital Trends will be released September 25. In this issue we examine the debt and equity flows for H1 2019 and report on deal activity across the property types for August.
Also by Jim Costello on RCA Insights: