Seeking Stability
The State of Commercial Real Estate Lending in 4Q2024
“What has been very challenging over the last two years is as rates went shooting up and have started to come back down, it was very difficult to determine what an actual cost of capital was and, therefore, what an accurate cap rate was to actually sell or buy a property. So, stability in rates is far more important to the market than the aggregate rate number.”
-Willy Walker, CEO Walker and Dunlop”
In today’s guest post, James Eng, a National Director at Old Capital Lending, will outline the dynamics of CRE financing, DFW sales trends, and the broader multifamily market. - Leyla
The commercial real estate (CRE) lending market in late 2024 is defined by one overarching theme: seeking stability. As volatility in interest rates continues to ripple through the sector, lenders, investors, and brokers are grappling with the challenges of financing and transacting in an uncertain environment. In this article, we will discuss:
1. Why stability matters more than interest rate levels
2. Federal Reserve policy and its implications
3. Supply and demand trends in the multifamily market
4. Sales trends in DFW
5. Foreclosures and refinances
1. Why Stability Matters More Than Interest Rate Levels
A central theme of the CRE lending market is the need for rate stability. According to the CEO of Walker & Dunlop, one of the largest agency lenders, the market's primary concern isn't necessarily the level of interest rates but the consistency of these rates. Volatility over the past two years has made it challenging to accurately price deals, set cap rates, and determine the true cost of capital.
The 10-year Treasury, a benchmark for determining lending rates, has experienced significant volatility. For instance, after the Federal Reserve's initial rate cut in September, the market anticipated declining rates. Instead, Treasury yields rose, impacting loan terms and valuations. A $1 million NOI property valued at $20 million at a 5% cap rate now requires higher equity contributions due to rising borrowing costs.
This instability has widened the bid-ask spread, leaving buyers and sellers struggling to align expectations. For transactions to gain momentum, a predictable cost of capital is critical.
2. Federal Reserve Policy and Its Implications
The Federal Reserve's current federal funds rate of 4.50%-4.75% is expected to decline further in 2025. Historically, rate cuts have signaled economic slowdowns, often followed by recessions:
For the CRE market, rate cuts could:
Ease financing costs: lower rates might boost refinancing and acquisition activity.
Trigger recessionary pressures: on average, recessions occur 5-6 months after the first rate cut, potentially impacting rent growth and property performance.
Source: CME Group
3. The Multifamily Market: Navigating Supply and Demand
With 550,000 multifamily units delivered in 2024, the market faces record-breaking supply levels:
This has suppressed rent growth in overbuilt markets like Austin (-5% rent growth) and parts of DFW (see chart below). However, a significant slowdown in new starts by 2026 could create favorable conditions for rent recovery.
Demand Dynamics
High homeownership costs have bolstered rental demand. The gap between monthly rent and mortgage payments, often exceeding $1,000, has kept prospective homeowners in the rental market, stabilizing occupancy rates for multifamily properties.
Renting is still a better deal compared to the cost of owning a home:
4. Sales Trends in Dallas-Fort Worth
The Dallas-Fort Worth (DFW) market offers a snapshot of broader trends in the CRE landscape. Here’s what we’re seeing:
Discretionary sales dominate: in Q3 2024, most sales involved A and A-minus properties, with minimal trading in B and C-class assets. Institutions are targeting newer, stabilized assets with minimal perceived risk.
Cap rate adjustments: A-class properties have seen cap rates rise modestly (from 4-4.5% to 5-5.5%), while workforce housing assets (B and C-class) have faced a larger increase in cap rates due to lower investor demand. Many sellers are not willing to sell at these elevated cap rates.
For more on cap rates, read our deep dive:
Lending Preferences
Shorter Loan Terms: Many buyers are opting for 5-year terms to mitigate prepayment penalties, anticipating potential interest rate cuts in the coming years.
Bridge Loans and Loan Resets: Bridge loans remain a significant part of the market, with many deals trading at or near the seller's outstanding loan amounts, particularly in the B and C-class segments.
All Cash Closings: We are seeing an increase in all cash closings, where buyers are possibly looking to obtain financing once interest rates decrease.
5. Distress and Refinances
While foreclosures in DFW remain limited, there are signs of increasing distress:
Occupancy-Driven Defaults: Properties with occupancies below 70% are finding it difficult to refinance or sell, leading to lender takeovers or GP (General Partner) replacements.
Loan Modifications: Lenders are increasingly modifying terms, reducing current pay rates, and deferring payments to avoid foreclosures. This trend reflects the lenders' preference for stabilizing assets over liquidating them at significant losses.
Refinances: We are seeing a wide variety in performance of deals purchased in 2021 and 2022. Some of those properties had NOI increase by over 50%, and those deals are now being refinanced to Fannie and Freddie loans. Others are being extended with new rate caps or interest reserves, and with some lenders are foreclosing.
Final Thoughts
The CRE market is at a turning point. While the road to stability may be uneven, those who can navigate the current landscape with discipline and foresight are well-positioned to capitalize on the next cycle.
About the Author:
James Eng, a proud Texan and University of Texas at Austin graduate with a degree in Finance, has called the Dallas-Fort Worth area home since 2006. He began his career as a Loan Underwriter at GE Capital Real Estate. Currently, James is the National Director at Old Capital Lending, where he has successfully originated over $1.5 billion in multifamily loans. James has invested as a limited partner (LP) in more than 40 multifamily properties across Texas. Connect with James via email at jeng@oldcapitallending.com and subscribe to his YouTube channel.
This was really informative, Leyla. Thanks. I presume that table from James Eng was for DFW?