December 18, 2015 RE Capital Market Insights: Present, Past, & 2016

Regulatory changes and market movements have dominated the news cycle for capital markets this month, so we’ve outlined the top items you need to know for what lies ahead in 2016.

Present: Interest Rate Hike
The U.S. economy entered a new era this week with the Fed’s decision to increase short-term interest rates for the first time in nearly a decade. This move did not come as a surprise to the market. After months of deliberation and allusions to a possible hike by members of the Fed, capital markets have already priced in the new 0.25%-to-0.5% rate increase. In their statement Wednesday, the Fed left the door open for further rate increases next year as the economic indicators continue to strengthen, and the economy reaches the 2% inflation target.

In its rational to initiate an increase, the Fed cited that the low interest rate environment has met its intended goal to stimulate the economy. The allure of the low interest rate environment in particular drove an influx of capital into the market from both foreign and national investors seeking to capitalize on the increasingly healthier US economy.

Past: Setting the Stage in 2015
Capital providers looking to fund investments flooded major gateway cities and primary markets, which resulted in investor focus and financing options shifting to secondary markets. The economic drivers in secondary markets have remained at healthy levels, along with strong jobs data and employment growth, giving lenders more comfort and resulting in a strong lending outlook for the upcoming year.

The conduit lenders and agencies each hit a minor roadblock in 2015. Conduit spreads widened significantly over the summer, driven by fluctuations in the Chinese stock market as well as an abundance of issuance. Agency lenders surprised the market early in the second-quarter of 2015 by curtailing lending and widening spreads due to lending capacity limits, with some exceptions for affordable and smaller properties.

Future: Looking to 2016
How the wall of CMBS maturities will impact the market remains one of the biggest question marks for capital markets moving into 2016.

We can see from the chart below that CMBS issuance saw positive year-over-year growth from Q1-Q3 2014 to the same periods in 2015; however, the market is holding its breath for the wall of CMBS maturities coming down the pipeline, unsure of its impact. Coupled with risk retention requirements beginning in 2016, this may impact the positive momentum built in the last few years and restrict the amount of capital available.

Dec Insights

Source: Commercial Mortgage Alert: Summary of CMBS Issuance

Considering all of this, 2016 is shaping up to be an environment framed by an increasingly constrained flow of capital and higher interest rates – albeit minor compared to the zero rate climate we’ve grown accustomed to for the past seven years. Increased regulatory stipulations will most likely affect leverage and pricing for traditional commercial real estate financing, and may push borrowers to less-regulated sources of capital to fill the gap. An uptick in interest rates could translate into lower cash returns for investors acquiring commercial properties; however, since a hike signals an improving economy, investors may be able to make up the difference with higher rental rates in a market that could support such an increase.