A Look at the 2021 Commercial Lending Market, with an Eye Towards 2022
After a severe interruption in lending on many commercial property types throughout 2020 due to the pandemic, 2021 has been a huge bounce-back year for the commercial real estate finance market.
What has the Commercial Real Estate Landscape looked like in 2021?
- Favorable capital conditions have proven ripe for commercial lending in 2021, as volume through three quarters has put the market on track for its most-active year since 2007.
- The surge in originations has been led by securitization programs, including CLOs (Collateralized Loan Obligations ), CMBS and Government Sponsored Enterprises (GSE), combining to float over $200 billion through the first 3 quarters of 2021, according to Commercial Mortgage Alert.
Lots of capital, Low rates
- A favorable interest rate market and large amounts of capital from all sources have created an enormous amount of volume, as there is more demand for properties than assets available, and prompted a large amount of deal flow. All lending platforms including CMBS, Life Companies, Banks, Credit Unions, Private, and Bridge Lenders have been producing large volumes of debt placement.
- Floating rate debt has been one of the biggest surprises in 2021, as borrowers have taken advantage of low rates with tight spreads, while many property sectors recover from the pandemic. Others have opted to take short-term floating-rate loans, with the expectation that rates will remain low and they can refinance at higher proceeds in a year or two.
Multi-Family Drives Loan Growth
- Much of the growth in lending in 2021 has been driven by multifamily. This can be seen most directly in the volume of loans purchased and securitized by the GSEs, which are the most active debt providers to apartments, supplying about 40% of the total annual volume. Through three quarters, the GSEs have securitized $101 billion of multifamily loans, putting them on pace to top the yearly high of $127.3 billion, set last year, per Commercial Mortgage Alert.
- Industrial has also been a favored product type, along with mini storage. Retail has come back fairly strong, especially for single-tenant credit retail, where demand is extremely high, driving cap rates into the 4% range. Grocery anchored retail and suburban retail with lifestyle/food-related tenants have also strengthened in better markets.
- Commercial and multi-family mortgage bankers are expected to close $578 billion of loans backed by income-producing properties in 2021, a 31% increase from 2020’s volume of $442 billion, according to a new forecast released by the Mortgage Bankers Association (MBA).
- Total multi-family lending alone, which includes some loans made by small and midsize banks not captured in the overall total, is forecast to rise to $409 billion in 2021—a new record and a 13% increase from last year’s total of $360 billion. MBA anticipates additional increases in lending volumes in 2022, with activity rising to $597 billion in commercial/multi-family mortgage bankers’ originations and $421 billion in total multi-family lending.
End of the Year Rush
- With interest rates remaining historically low and the looming limitations on 1031 exchange’s proposed by the Biden administration, there is a mad rush to close 1031 exchanges in 2021, causing a frenzy, which is clogging the third-party vendor sector, creating long turnaround times, and report costs to increase to unprecedented levels. The same pressures exist amongst the lender staff and title companies.
What does 2022 look like?
- MBA anticipates additional increases in lending volumes in 2022, with activity rising to $597 billion in commercial/multi-family mortgage bankers’ originations and $421 billion in total multi-family lending.
- Although US Treasury indexes have risen of late, overall coupon rates have remained fairly flat, with some spread compression offsetting the treasury rise.
- Many lenders have cut off end-of-the-year closings and are looking to fill their start of the year 2022 pipelines. All lender sectors surveyed expect/want to do similar to slightly more volume in 2022, assuming lending conditions remain stable to improving in Covid hit sectors. The office market and Hospitality segment of the market will be of keen interest to see if those products gain more traction, as workers come back to the office and travelers continue to expand both for business and leisure. All things remaining similar or improving and it should be another extremely active and favorable lending environment returning large record type volume potential.
- Areas to keep an eye on that can effect the strong momentum of the market are the obvious increase in interest rates, any type of Covid recurrences / increased levels, passing of the Biden proposed limit on 1031 exchanges (see below), and the recent political unrest throughout the world.
Looming 1031 Exchange rule changes would have a major impact on commercial real estate sales volume.
- Commercial investors worry about possible 1031 exchange rules.
- The Biden Administration wants a $500K limit for like-kind exchanges, which allow investors to defer taxes. If enacted, the change could have a big impact on commercial real estate sales.
- One proposal in President Biden’s $1.8 trillion American Families Plan has been drawing close attention from concerned commercial real estate investors. It would place a $500,000 limit on 1031 exchanges, which allows investors to defer paying tax on real estate gains if they reinvest the proceeds to buy other property within six months of the sale.The bill would limit gains to $500,000 for each taxpayer ($1 million for married taxpayers filing a joint return) each year for real property exchanges that are like-kind. Any gains from like-kind exchanges in excess of these limits would be recognized by the taxpayer in the year of the exchange. The tax break has been in the U.S. tax code since 1921.
Putting a limit on 1031 exchanges would absolutely slow down the movement of capital in the industry.
A proposed increase in the capital gains tax from 20% to 39.6% would also reduce returns for real estate investors.
According to a study supported by accounting firm Ernst & Young, eliminating 1031 exchanges would negatively impact the economy by up to $13.1 billion annually. One analysis (backed by research from Ernst & Young) found that a repeal of 1031 exchanges would likely result in less federal tax revenue.
Many believe the proposed cap originated with people who don’t understand how the 1031 process works. Once people understand the process and what it is doing [for the economy], very few people would want to have it eliminated. Any potential changes in the 1031 rules are certainly a concern and would certainly lead to less sales volume.