Commercial Real Estate Debt: Musical Chairs
With falling sales volume and normalized maturities, the supply of mortgage loan opportunities will be significantly less this year.
Mortgage origination volumes of $540 billion in 2017 broke the record set in 2007, but we do not believe this trend will continue in 2018. While lender demand remains strong, supply is likely to wane due to declining sales activity and lower new construction completions for most property types. Additionally, most borrowers likely to refinance have already done so, and Agencies have signaled skepticism about the potential for continued origination growth after two years of frenzied activity, particularly in multifamily originations that accounted for 44 percent of new loans.
Mortgage Origination Is Likely to Slow in 2018
Mortgage origination volumes of $540 billion in 2017 broke the record set in 2007, but we do not believe this trend will continue in 2018. While lender demand remains strong, supply is likely to wane due to declining sales activity and lower new construction completions for most property types.
Source: Mortgage Bankers Association CREF Database. Data as of 12.31.2017.
Our sector has attracted nontraditional lenders to the market, which warrants some attention as it could lead to an oversupply of capital. Private funds have seen a significant increase in lending volume over the past two years, and this is expected to increase again in 2018. Private funds have raised equity capital faster than they are investing it and have turned to mortgage debt to provide short-term high yields to their investors. These private funds initially tried to fill the void left by banks on first-lien construction loans and have since migrated to bridge financing to deploy funds and provide yield. Banks and life insurance companies have a strong appetite for bridge financing. As with any supply/demand imbalance, spreads have tightened for this product and all product types other than construction loans in the first quarter. We do not expect this trend to change for the rest of the year barring an unforeseen disruption in the markets. Instead, competition for product will put downward pressure on pricing and, perhaps more worrisome, underwriting will get more aggressive to win transactions.
As Libor rates continue to rise, we see opportunities for lenders that can provide fixed-rate coupons for bridge transactions as a way to differentiate from the pack. With the cost of new construction still increasing, we are constructive on the bridge transitional product as a way for borrowers to compete at a lower rental basis. With 10-year Treasury yields near 3 percent, longer-term loans beyond 10 years are becoming more attractive and have less competition than traditional seven- and 10-year terms.
Debt Funds Show Signs of Significant Growth
Closed-End Private Real Estate Dry Powder by Fund Type
Strong demand has attracted nontraditional lenders to the market. Private funds have seen a significant increase in lending volume over the past two years, and this is expected to increase again in 2018 given substantial dry powder. This could result in an oversupply of capital and may lead to further deterioration in underwriting standards.
Source: Preqin, Guggenheim Investments. Data as of 3.31.2018.
—William Bennett, Managing Director; Ted Jung, Vice President
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*Assets under management is as of 6.30.2019 and includes leverage of $11.2bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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