In 2015, we saw a continued low interest rate environment, the implementation of Basel III regulations and a multitude of new entrants to the market in all areas of the capital stack. Looking ahead at 2016, we will see additional constraints put into place on capital flows. These increased regulatory stipulations and constraints on capital will effect leverage and pricing for commercial real estate and have borrowers seeking non-regulated sources of capital to fill the gap.
Risk Retention Requirements for CMBS Lenders
As required by the Dodd-Frank Act, the final credit risk retention regulations for asset-backed securities (ABS) is set to be implemented in 2016. This may limit the amount of capital that is available as well as increase the cost of CMBS capital, if it is implemented as written. Groups will have to shift their perspective and investor base to attract longer-term capital due to the five-year hold mandate.
The regulations essentially require a securitizer of ABS to hold 5% of the credit risk of any asset collateralized by issuance for a minimum of five years from the closing date of securitization. On the positive side, well-capitalized funds are being set up to take on the additional risk. While that will help with the availability of capital, it will ultimately have a negative impact on spreads.
FHFA Keeps GSE Multifamily Cap at $30 Billion Each and Adds New Exclusions
In October 2015, the FHFA maintained Fannie & Freddie’s lending cap at $30 billion each in 2016; the same amount as 2015. However, a new quarterly review will be instituted to ease concerns over possible cap breaches and allow for potential adjustments, given current market conditions.
In addition to the exclusions added in 2015 to prioritize affordable housing, low-income apartments in rural areas, senior housing loans, small multifamily properties targeting low-income tenants and energy efficiency improvements will also be excluded in the year to come.
In April of 2015, Fannie and Freddie widened spreads and tightened underwriting in an effort to slow down their lending programs, which were on track to exceed their annual limit of $30 billion by the third quarter of 2015. If by year end, the agencies have reached their cap and a deal does not meet the list of exclusions, companies with balance sheet capabilities could have a distinct advantage by providing financing and holding the loan on book until the cap is refreshed in 2017.
EB-5’s Future at Stakes
The EB-5 visa, a method of obtaining a green card for foreign nationals that invest money in the U.S., was created in 1990 with the intent to bring investments that would in turn create jobs in the U.S. However, the program began receiving more attention as a result of the financial crash.
Critics say the visa program is poorly regulated, susceptible to fraud and provides an unfair “fast pass” to citizenship for the wealthy. Over the years, some developers have even benefited from this alternative and cheap source of capital by bending provisions meant for rural or high-unemployment areas.
The program was originally set to expire on Sept. 30, 2015, but was extended until Dec. 11, 2015 when Congress will vote on further legislation for the program. California Senator Diane Feinstein, who recently voiced her disapproval for the program and stated it “puts a price on citizenship,” will likely use this opportunity to call on Congress to end the program.
The EB-5 visa program has grown over 700% from $321 million in 2008 to $2.56 billion in 2014, and is expected to generate $4.4 billion in foreign direct investments for 2015. In 2014, a total of 10,692 EB-5 visas were issued, with 85% of those allotted to Chinese investors.
To some, this could be a wakeup call to steer away from programs that rely on government programs and regulation for real estate funding.
The quality of capital seems to be increasingly constrained by regulatory stipulations. Banks are constrained by regulations, the agencies have been capped and risk retention requirements on CMBS may create an artificial cap on CMBS lending. Naturally, a portion of the mortgages have been paid off through defeasance due to low rates but the wall of CMBS maturities is coming and many are concerned with what volume can be met by these highly constrained capital sources. From this, we may see more non-regulated finance companies stepping into the lending space as the banks and CMBS shops that provide over 50% of capital on an annual basis are having their capital limited.