August 17, 2016
The Mortgage Bankers Association is forecasting a 1 percent decrease in loan originations for 2016 as compared to last year’s $504 billion, but we are not as optimistic. We believe originations will be 5–10 percent below last year’s results, thanks in part to a 16 percent decline in sales volume in the first half of 2016 compared to last year’s record-setting volume. This drop off was consistent with the risk-off sentiment of the first and second quarters, and reflected concern that valuations in the U.S. real estate market had peaked over the past 12 months. The overriding fear was that a decline in foreign capital coming into the real estate market would slow the pace of purchases, and lending costs would increase, especially as loan-to-value ratios rose above 70 percent. Nevertheless, this concern will likely be unfounded, as foreign capital should continue to flow into real estate assets with stable yields, spurred by higher risk for new real estate investments in post-Brexit Europe. Cap rates are historically low but the spread between the 10-year U.S. Treasurys and current cap rates is one of the highest in the last 15 years—other than the last two financial downturns.
Optimistic street projections for total commercial real estate loan originations seem out of line with recent commercial real estate sales volumes, which declined by 16 percent in the first half of 2016. We expect loan originations to end the year approximately 5–10 percent lower than 2015.
Source: Bloomberg, Guggenheim Investments. Data as of 6.30.2016.
The first half saw a leveling off of cap rates and overall returns on an unlevered basis as reported by the National Council of Real Estate Investment Fiduciaries (NCREIF) were 4.2 percent for the first six months and will probably be less than 10 percent this year, indicating a return to more normalized returns. As our CMBS team discusses on page 18, issuance was down in the first half of 2016, but commercial mortgage lenders took up the slack. While overall first-half originations are almost identical to the same period last year, we do not think this pace is sustainable for the remainder of the year.
With this anticipated lack of liquidity, borrowers will have fewer lending options in the second half of 2016, especially at loan-to-value ratios above 70 percent. This will set the stage for wider spreads and tighter underwriting standards, a double benefit for lenders. We still find strong relative value in higher-yielding bridge capital for new acquisitions and traditional long-term permanent loans.
Much like yields across U.S. fixed income, cap rates in the commercial real estate market have declined to historic lows, averaging only 5.2 percent as of the end of the second quarter. However, average cap-rate spreads to Treasurys of 352 basis points continue to look attractive. This spread over government bonds is keeping demand for commercial real estate loans alive, particularly from foreign investors.
Source: Federal Reserve Board, NCREIF equal-weighted current value cap rates. Data as of 6.30.2016.
—William Bennett, Managing Director; David Cacciapaglia, Managing Director
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Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment-grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating-rate senior-secured syndicated bank loans and other floating-rate securities involve special types of risks, including credit risk, interest-rate risk, liquidity risk and prepayment risk.
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