CMBS bankers and borrowers are eagerly awaiting lower rates as way to usher in cheaper financing, hoping this can lift commercial real estate valuations and stoke issuance volumes.
But although market participants are right to be happy about lower rates, it will take more than a couple cuts to make a meaningful impact for borrowers
After the Fed has been playing a careful game of threading the needle to perfectly time lower rates, that a cut is coming along soon is already being taken as a given.
CMBS market participants are enthused. They sense that the end of the worst is near for the CMBS, which felt the pain of the Fed’s “higher for longer” mantra to oust inflation more than most asset classes.
Yet some of that excitement is misplaced. In reality, meaningfully lower borrowing costs remain far away.
Sure, that borrowers will soon be able to obtain better financing costs to fund acquisitions or to refinance is cause for encouragement. But it will take more than one or two meager 25bp cuts for there to be a tangible benefit.
On the margins, some deals perhaps may benefit immediately, as it suddenly makes sense for them to get done with better cap rates and debt coverage ratios. Yet we are talking about marginal deals here or there — not a sizable amount of issuance that will significantly move volumes.
Unfortunately, for a lot of CMBS borrowers, rates are so far from making sense that they will need several more cuts. For example, an S&P CMBS report published in early July said that, out of 50 SASB offerings priced in the first half of 2024, they had declined provide a rating to 18 — largely because they could not cover debt service on day one based on projected cash flows and Sofr’s level.
A deal like this needs far more than a 25bp cut to stop suffering. Most loans require a large shift in policy, rather than a few nudges in that direction, for refinancing to really become attractive. Deals now are being financed with Sofr at around 5.3%, up from 0.5% in 2021-2022.
Even a handful of rate reductions is likely to see Sofr remain historically high.
As an S&P report from May notes, the influx of SASB deals with debt service ratios close to 1.0 times have little room for error. These deals are barely above water to weather disruptions to cash flows, even considering the benefit of lower rates on floating rate financing.
So sure, be encouraged. But also be aware that this is still the early stages of the recovery.
The excitement in the CMBS market should be because we will eventually be heading for a period of markedly lower rates — not that a handful of 25bp downward moves this year will revive market activity overnight.
While 2024 might not see much hype around rates transfer into activity, it is 2025 that will be the year where that is set to change course.