Bond markets demanding higher rate of returns from real estate capital borrowers, reports The Real Estate Capital Institute

 

 John Oharenko

Chicago, IL – ^The   Real Estate Capital Institute^®  reports real estate capital markets are becoming accustomed to higher costs of debt and equity. 

 

Even as the Fed recently stopped announcing rate hikes, the bond markets demand higher rates of return given the current domestic economic uncertainty combined with global conflict, mainly in Ukraine and the Middle East. 

 

"Based on varying market forecasts, 2024 should look much like 2023.  Investors are feeling out the markets and patiently waiting for new buying opportunities to emerge in light of 'higher' funding costs," notes John Oharenko, Director of The Real Estate Capital Institute®.

 

Yet even as the funding environment remains challenging,  transactions occur but under "higher" conditions summarized below:

 

Higher Volatility:  The fast-paced increases and decreases in benchmark yields during the past few months keep lenders and borrowers confused about market direction.  Lenders respond by raising spreads, while borrowers retreat unless burdened by debt maturities.  While treasuries hit the 5% benchmark in October, recent pricing is more favorable, potentially reflecting greater stability for the winter months.

 Higher Debt Costs:   Rates doubled during the past two years.  Furthermore, the trend continues for longer-term debt, priced more competitively than short-term debt.  With higher mortgage spreads, floating-rate loans start at about 7.5%, while fixed-rate permanent debt can be as low as 5.5% for prime-quality properties.  In addition to softening market conditions, the more expensive debt pressures lower property values, as the negative leverage discourages transaction activity.

 

Higher Spreads:  Expensive debt is due to higher underlying benchmark rates and wider spreads as investors crave more yields to move funds into real estate.  Spreads of 150 basis points or more over benchmark treasuries are the norm.  However, as mortgage markets suffer from lackluster demand, expect spreads to narrow in the next few months. 

Higher Expectations: Although floating-rate debt remains more expensive than fixed-rate loans, many borrowers expect rates to drop in the foreseeable future.  Such players avoid locking into fixed-rate debt terms, which they hope will soon be more favorable.   Otherwise, the choice of fixed vs. floating rate debt ties into the project economics, mainly the quality and durability of the cash flow.

 

 

 The Real Estate Capital Institute® is a volunteer-based research organization that tracks realty rates data for debt and equity yields. 

 

^CONTACT:

John Oharenko,

 Executive Director

director@reci.com / www.reci.com

^The   Real Estate Capital Institute^®

Chicago, Illinois USA 60622