By: Charley Babb
Anybody in the market for a Commercial Mortgage-Backed Security loan (CMBS) for his or her commercial real estate asset in the past three months has been on a bit of a roller coaster ride. Typically, the interest rate paid on a CMBS loan with a 10-year term is the sum of the 10-year U.S. Treasury Swap Rate and the lender spread at the time that the loan closes. On May 3rd the 10-year Swap Rate was 1.84%. Today it sits at almost a full point higher at 2.80%. Lender spreads also widened out considerably as there was increased fear of losing money when securitizing their loan portfolio. The changing interest rate environment has created a tumultuous time for buyers and sellers of commercial real estate and for those who were looking to refinance their properties.
What precipitated this relatively dramatic rise in U.S. Treasury rates and the widening of lender spreads? Federal Reserve Chairman Ben Bernanke commented in June that the Fed would start tapering back its program of purchasing government securities and mortgage-backed securities, known as Quantitative Easing (QE). Well, for about a month afterwards all hell broke loose in the bond market, sending the effective interest rate a borrower would pay for a loan up about 145 basis points (1.45%). Mr. Bernanke has since tempered his comments a bit, and the bond markets have settled into a new normal that reflects a sense of relative calm, albeit at these new levels. Nevertheless, the damage may already have been done for borrowers in the market for new loans this summer.
Most of the CMBS lenders run in herds. The fear that gripped them and caused dramatic widening of spreads in June has subsided. Slowly and cautiously CMBS Lenders are tightening their spreads again as the marketplace works its magic and they compete for desirable transactions. That said, what about the deals that were in progress in May and June of this year?
An example might be helpful in demonstrating the effect, so consider an office transaction for which we were engaged to secure the acquisition debt. Our client was attempting to acquire a multi-tenant office building and was looking for the maximum leverage with a fixed-rate of interest for 10 years. When our Client first looked at the offering memorandum in May, interest rates for the transaction were in the range of 4.1-4.25%. Our Client underwrote the property and made their offer based upon an anticipated current Cash-On-Cash Return of about 10% on invested equity.
By the time we entered the market with requests for lender term sheets in early July, Metropolitan Capital found a very competitive set of CMBS lenders all quoting the transaction at 75% of the purchase price. The early term sheets that we received reflected an interest rate in the range of 5.35-5.6%. As the transaction has progressed, the lenders have all voluntarily reduced spreads in the interim by an average of about 20-25 basis points. The resulting interest rate today is approximately 5.1%, or 100 basis points higher than when our client first analyzed the transaction. So the net effect of the incurred interest rate dropped the Cash-On-Cash Return from 10% to 8%.
And while an interest rate of 5.1% for a 10-year loan on an office building is still pretty stellar by historical standards, this deal may not survive the comments of Mr. Bernanke – at least not at the purchase price originally anticipated. It would appear that CMBS interest rates have settled down for the foreseeable near term. Borrowers will have to adjust their pro formas accordingly, and Sellers may indeed need to drop their asking price. Fortunately for both sides, we are no longer looking at a runaway train with respect to interest rates…at least for the time being.
For the most up-to-the-moment feedback on CMBS interest rates, spreads, and underwriting, contact any one of MCA’s Senior Directors by visiting our website, www.metcapital.com.