There are some excellent opportunities in commercial real estate if you select the right assets, says Thirty Capital CEO Rob Finlay.

In today’s podcast roundtable with his team of analysts, Rob explains that while commercial real estate is facing some headwinds, “there is a tremendous upside for the right assets.”

Meanwhile, rates are moving upwards following last Wednesday’s Fed meeting, during which the board agreed to let around $90 billion run off the balance sheet every month. That, along with strong employment numbers on Friday, led to a mini bear market.

Two-year swaps moved up about nine basis points. Ten-year SOFR swaps moved up 31 basis points.

Hard to draw parallels between today and 2018

Analyst Jay Saunders said the markets saw this back in around 2016 to 2018, during the last Fed tightening cycle. “We saw long-term rates generally move up in line with the Fed until we got to 2018, which was the last time we saw these yields 2.75 to three percent on the Ten-year.”

Rob says the market is still around 50 to 60 basis points off pre-pandemic levels. Back then, the market was around 3.30 before it started to sell off.

However, Jay says it’s hard to draw parallels with economic circumstances four years ago. There was no inflation, no coronavirus, and today employment is very strong.

A transition from floating to fixed

Analyst Jeff Lee says Thirty Capital is seeing a big transition from floating to fixed rates. He cautions that commercial real estate borrowers may need to get a little creative with their borrowing.

“With some of the steepening, you can make it back up on the curve a little bit to drop a few basis points here and there. But it’s not as big as that move used to be before,” explains Jeff.

“But on the flip side we’ve heard a lot of people say they have to go interest-only to keep monthly payments similar to what their prior loan was.”

Local banks will be beneficiaries of ‘weird’ market

Both Jeff and Rob discuss how commercial real estate borrowers are leveraging relationships with their local banks to get loans. Say’s Rob: “I think regional banks are going to be the beneficiaries of everything that’s going on in this market. You can’t underweight a deal in Vero Beach Florida without really knowing the market and knowing the dynamics.”

Adds Jeff: “It’s the relationships and the local pulse. It’s got to be what fuels us through this weird kind of time.”

This episode includes:

• Jay’s analysis of the SOFR market and rate increases.
• Figures coming out this week are CPI and PPI.
• Get deals done early this week because the markets close early this week due to Good Friday.

The team also gives its prediction on the Ten-year in coming months. Listen to the full episode for their conclusion!

Follow Rob on Twitter and LinkedIn.

Five out of the last six times there’s been an inverted yield curve, a recession has followed.

But the team of analysts at Thirty Capital thinks that if a recession does occur, it won’t happen in the very near future.

Says Thirty Capital Analyst Bryan Kern: “The Fed has only hiked 25 bps, so they haven’t really done anything yet, outside of providing commentary that’s sent the market into a tailspin.”

Talk of a recession is premature, overblown

Bryan does note that there are some signs of slowing growth, particularly in retail sales. The question now is if the U.S. does have a recession, when will it happen?

He thinks if a recession does occur it will be in 2023, and it won’t be severe. Of course, no one can predict the future, but Bryan believes the current narrative about an impending recession is premature and overblown.

He adds it's important for the markets to focus on what’s at hand right now - high inflation and a war in Ukraine.

80 percent chance of a half point hike

The markets are expecting a full half point increase announcement at the Fed’s meeting next month.

Analyst Jay Saunders points out that there is a fairly significant inversion in the SOFR swap curve, with the three-year point being the highest. He says that short-term rates will head north of one percent in the next few months. Listen to the full episode for Jay’s details of SOFR rates and what’s happening with SOFR in the episode.

Caps much more expensive

Despite the volatility, commercial real estate borrowers are busy and completed a lot of deals ahead of the end of the first quarter. Jay says borrowers need to think about how they will purchase a cap for any upcoming deals and how they intend to address their caps, given that they can be so expensive.

Jay says the next thing the markets can watch out for is the Fed and its balance sheet. “I think the Fed would like to see long-term rates quite a bit higher than they are. They don't like inverted yield curves. And the way to do that is to start accelerating how quickly they unwind their balance sheet.”

In the past, people could go for a five- or seven-year loan. But this flatness wipes all that out.

Forward Fed funds predicting high rates

Analyst Jason Kelley says that forward Fed funds are predicting much higher rates, up to three percent next year. His analysis is that the market believes the Fed is going to overdo it and “just blow through, then we’ll have some kind of recession and rates will come back down.”

He says Thirty Capital is looking at putting some hedges on internally. They are going to skip the ‘23 and ‘24 tranche and lock in some of the ‘25 and ‘26 rates.

Jason gives an analysis of the current market conditions and their impact on the commercial real estate market.

Listen to the full episode for the team’s full analysis on market activity and how this impacts commercial real estate investors.

The Ten-year Treasury has been all over the place in the past few days, as the yield curve continues to flatten.

There have been wild intraday swings as well as - of course - movement within the past few days.

Thirty Capital Analyst Bryan Kern says: “We’ve seen a ton of volatility, but obviously the general trend is upwards.”

The Two-year was up 16 bps and the Ten-year 18 bps, briefly touching 2.50 on Friday. In the last two weeks the Ten-year is up about 32 bps and about 42 bps on the Two-year.

Ten-year artificially low because of quantitative easing

Bryan believes that the Ten-year should be much higher than what it is, given all the qualitative easing that happened during the pandemic.

Bryan says he doesn’t see a recession in the next 12 to 18 months, despite there being a lot of talk about an impending recession in the news.

“I believe the Ten-year is artificially low because of quantitative easing,” he says. “Realistically, we shouldn’t be anywhere near an inverted curve with what’s going on.

“Once the Fed stops buying treasuries, and if they actually quantitatively tightened, we'll see that Ten-year spike,” Bryan continues.

He adds that there is a 75 percent chance of a 50-bps hike in May, and that it is likely the Ten-year will head higher, with the floor for the next quarter at 250.

Sticker shock on some SOFR pricing

Thirty Capital analyst Jay Saunders says some clients are experiencing sticker shock on some of the pricing of deals.

Looking at SOFR swap rates, three-year SOFR swap rates were up 36 bps last week.

The highest point on the SOFR swap curve right now is a three-year SOFR swap. It's the high-rate, high benchmark on the curve. From there, it goes downhill, all the way out to 30 years.

Jay adds that the Three-year treasury has increased 144 bps in the first quarter of 2022. That’s the largest move up in the Three-year treasury in 50 years.

The short-end of the rate curve is very reactive to the Fed

Jay says commercial real estate borrowers can expect to see all the rates creep up as the next Fed meeting nears.

Short-term rates have pulled in the last Fed increase. One-month LIBOR is now trading at 45 bps, one-month SOFR at 31 bps, while the three-month LIBOR is one percent.

He adds that while many analysts are predicting high rate increases, he believes the Fed will be more measured with interest rate hikes.

“Clearly the market's anticipating short-term rates going up quite a bit and that's forcing the short-end of the curve up. The long-end is just not keeping up.”

He adds that commercial real estate clients are concerned about where rates are going, and are prudent when it comes to buying rate protection.

You can hear the full update, news, and analysis by listening to the full episode. Be sure to follow Thirty Capital CEO Rob Finlay on Twitter and LinkedIn.

In this week’s Capital Markets Report podcast, The Thirty Capital team takes a look at this and what it means for commercial real estate borrowers.

Explains Analyst Jason Kelley, the curve is “Continuing to get more and more flat. There's really no difference between a Five-year and a Ten-year treasury . . . about one basis point (bps) difference.” 

Meanwhile, the Two-year continues to creep up. In the last year, it has moved up more than 186 bps, compared to the Ten-year’s increase of 52 in the same time period.

What do commercial real estate borrowers need to know?

Thirty Capital CEO Rob Finlay says commercial real estate borrowers need to remain aware that rates have winded out and spreads have winded out as the capital markets are repricing loans and other products in the space.

“From an underwriting perspective, make sure you widen out a little bit and be a little bit more conservative with your pricing assumptions,” Rob cautions.

Market thinks the Fed’s getting it wrong

There were a few days last week where the curve went inverted for intraday trading, with shorter yields passing the long-term yields.

What’s happening now is a continuation of the same story we’ve had for a while. Jason explains that “The market's thinking the Fed's going to get it wrong; that the Feds will force rates up, force a bit of a recession, and then they're going to have to backtrack.”

Inflation is real, not transitory

Rob agrees with Jason, saying: “There's no way to do a soft landing here. I think it's a fantasy world to think that this inflation is just transitory and not real.”

Thirty Capital Analyst Jeff Lee cautions that the inflation numbers from last week don’t account for the Ukraine situation, so consumers can expect eight points or more in the next inflation numbers.

What’s a commercial real estate borrower to do?

Jeff says his team is closely watching a lot of deals in progress right now. Many of them have to be repriced or re-traded and investors are getting double whacked from spreads in the Ten-year.

Only a couple weeks ago, Jeff talked about spreads widening by around 40, 50, 60 bps. That, along with the increase in the Ten-year, means a borrower could be looking at 150 basis points from where they were a month or two ago

Rob says that borrowers should look at the current situation and see that long-term is the way to go. “For the most part, short term debt is off the table.

“Even where the capital markets have widened out a little bit, long-term is still a pretty smart play.”

No end to the volatility just yet

Market volatility is expected to increase for the next six months or so as the Fed marches ahead with rate increases.

“Until they indicate that they are going to pause, we’re going to continue with this volatile correction,” Jason notes.

Listen to the full episode for the team's complete analysis and guidance on how commercial real estate borrowers should be responding to today’s market conditions.

The futures market is actually expecting about 165 basis points and tightening in 2022. So there are many who think the Fed will go for a .50 bps increase, but Thirty Capital Analyst Bryan Kern says the consensus around .25 is probably right. 

For commercial real estate borrowers, this means more of the same, with high volatility and thinner markets, says Bryan.

Commercial real estate borrowers must watch out for cap prices! 

If you are in the market for hedging products, get regular updates on cap prices, because they are going up due to market volatility.

Says Thirty Capital Analyst Jay Saunders: “We have a client who did not execute a cap Friday. It’s $10,000 more expensive today than it was Friday.”

He warns borrowers to really think about strike rates on these gaps. “I know borrowers want leverage. They want low strike rates so they can lever up these projects. 

“But when three-year, two-percent caps cost 65 to 70 basis points per annum you’ve got to start thinking about the math . . . where (the numbers) do and don’t make sense.”

Watch out for intraday movement on the markets

To add to Jay’s warning, Bryan cautioned commercial real estate borrowers to be vigilant for intraday movement. On interest rate caps there can be a swing between 16 and 17 bps in a matter of minutes. 

COVID spike could impact supply chain

Jay points to the news out of China that COVID cases are at a new high since the outbreak just over two years ago. Jay asks if this is going to be a body blow to international supply chains, and just how much it will impact business in the U.S.

What’s happening with short-term loans?

LIBOR legislation has passed in Congress. This allows allowing Federal calculation agents to force a transition from LIBOR to the preferred fall-back, which would be either one- or three-month term SOFR rate for contracts that don’t have workable fall-back language. The AARC is likely done with the transition now that this legislation has passed.

BSBY is still lagging behind the SOFR and LIBOR, coming in at about 32 bps for LIBOR’s 43, notes Jay. So LIBOR has obviously priced in the Fed increase coming on Wednesday. 

Jay notes that the curve continues to flatten, and he believes that “Clearly the market anticipates the Fed plowing forward with its rate increases. 

Market tries to anticipate Fed behavior

“But the market also seems to be anticipating a very 2019-esque overdoing by the Fed, to be followed by Fed rate cuts within the next couple of years. 

After this month’s increase, the next Fed meeting is in May, and rate cuts are expected for the next six meetings, although Thirty Capital believes the Fed may get derailed on those plans.

The war in Ukraine is massively impacting the capital markets, with volatility pervasive in every single corner of the financial markets.

Last Thursday, there was a seven percent swing in the NASDAQ from high to low, while oil prices moved about three percent on average every day.

Also last Thursday, the Ten-year Treasury fell 12 basis points at the open and then rose 10 basis points (bps) to finish the day nearly unchanged. Thirty Capital Analyst Bryan Kern says that across the curve rates are down about six to 12 basis points, depending on the part of the curve that you're watching.

“We've got a lot of folks in the market who are looking to buy caps and it seems like we have to update those every 20 minutes. The price has changed wildly,” explains Bryan. “We caution folks as they look to purchase interest rate caps to continually get updates . . . just be prepared for price swings.”

It’s going to be a wild week on the capital markets

Thirty Capital Analyst Jay Saunders says this week could be one of the wildest the markets have seen in a long time. Federal Reserve chairman Jerome Powell will testify before Congress on Wednesday and Thursday. Powell’s words will be watched very closely by market analysts, as they will likely be his final public comments on monetary policy ahead of the U.S. central bank raising interest rates to fight decades-high inflation.

And tomorrow - Tuesday, March 1 - President Joe Biden will give his State of the Union address. On Friday, employment numbers will be issued, along with a slew of other economic data.

Jay adds that while many seem to have forgotten about COVID, it’s still there and impacting the markets and the economy as a whole, as is, of course, Russia’s invasion of Ukraine.

What does all this mean if you’re in commercial real estate?

Bryan notes that this week has started with curve steepening slightly. The Two-year is down about 11 bps, while the Ten-year is down about eight, so it’s steepened by about three bps from Two-year to Ten-year.

SOFR swaps are a bit more dramatic, and Bryan details the numbers in this episode.

Thirty Capital CEO Rob Finlay says that for anyone in commercial real estate, longer term borrowing is going to be much more attractive.

Thirty Capital Analyst Jeff Lee gives the full picture on what’s happening with CMBS, which, he says, is extremely volatile right now. He says that current levels of volatility mean that deals that were in progress a few weeks ago are now being re-traded. Says Jay: “Some of the new deals . . . they don’t want to tell the borrower, but they’ve lined out probably 40 to 60 basis points.”

Rob points out that listeners should note how the credit markets have widened out. He asks people to look out for the amount of time between the credit markets widening out and when real estate assets trade.

“It’ll be really interesting to see how much of a lag there is in commercial real estate, relative to these credit markets,” Rob notes.

Will the war in Ukraine influence the Fed’s interest rate agenda?

Bryan still believes there will be a rate hike in March, but probably at 25 bps increase, not the 50 bps that the market has been anticipating. He adds that the Fed likely doesn’t want to add to current volatility.

Meanwhile, short term rates are starting to increase as the Fed March 25 meeting date nears. This is obviously going to affect everyone with floating rate debt.

Only time will reveal the true impact of the war in Ukraine

Thirty Capital Analyst Jason Kelley says that we need to wait to understand the true economic impact on the markets of Russia’s invasion of Ukraine. In the short term, the value of the ruble has fallen and the price of oil continues to increase. The oil factor is putting the  Fed in a tight spot because oil is a big part of the inflation factor.

Inflation has reached a 40-year high, with the Consumer Price Index posting a 7.5 per cent annual gain.

Panic and speculation impacting markets

The Two-year treasury actually jumped 21 basis points, mostly due to speculation that the Fed may actually hike by 50 basis points in March. Some are predicting even a 100-basis point increase by mid-summer.

Says Thirty Capital Analyst Bryan Kern: “We’re not really sure how it’s going to pan out, but there was a lot of panic, a lot of speculation.

“Then of course there was some news surrounding the potential invasion of Ukraine by Russia on Friday, so we saw rates kind of pull back a little bit,” he continues. “With all this volatility net net from last Monday to today, we're up about 6.5 to seven basis points.”

Thirty Capital Analyst Jeff Lee says that on the financial side Thirty Capital is seeing a 30 plus percent increase in requests to reprice or forecast deals. “Everyone’s forecast is definitely fluid and changing.”

Meanwhile, Thirty Capital Analyst Jay Saunders points out that last week Two-year SOFR swaps moved up 24 basis points alone on Thursday. “You just don’t see movement like that . . .  so the short-end of the curve is very volatile.”

Cap market struggling

Things were so crazy that at one point on Friday the cap market was completely frozen. “You simply could not buy a cap . . . there was not a dealer on the street,” says Jay.

For commercial real estate investors trying to understand what the cap lockup and freeze means, Jay explains that over the next six months or so “as we go through what I suspect will be this change in the Fed's policy, we'll start to see actual rate increases to the extent that you can get some flexibility with lenders as to when you purchase these caps.

“Anything that involves some kind of optionality, it’s going to be really, really hard to put a price on it,” he explains, adding that he can’t recall seeing a cap lock up and freeze ever before.

“It’s a very strange market,” Jay comments. “It may work itself out quickly when we start seeing some calm come back into the market, but right now it is very volatile.”

Looking at termination? Be aware of intraday volatility

Bryan warns commercial real estate investors to be wary of the volatility that can run through the market in an eight-hour period.

In this week’s episode he explains how Thirty Capital had to terminate a couple of swaps, and with one, a bank paid a premium to get out of the contract.

Be opportunistic through this volatility and inflation

Thirty Capital Analyst Jason Kelley says that inflation will continue for a while, but should peak this year. He notes that inflation is highest in the energy sector, but doesn’t think that gas prices will increase again.

Says Jason: “You're going to see big swings and it's a good time to be opportunistic and actually work with someone that's got the screens to see where the market's moving.”

The markets are seeing an incredible flattening of the yield curve right now - reflecting uncertainty beyond the upcoming Fed rate increases.

Thirty Capital Analyst Bryan Kern explains that the long end of the curve is very different from the short end, as expectations around Fed rate increases in the next two years come into play.

“Beyond rate increases there is uncertainty, so the Ten-year just sort of whipsaws based on some of the economic data we are seeing,” explains Bryan.

Will there be an inverted yield curve this year?

Bryan doubts there’ll be a completely flat yield curve in two years or so, but Thirty Capital Analyst Jay Saunders disagrees, saying he believes the yield curve will become very flat and perhaps even inverted.

“Clearly the market hasn’t bought into the argument that inflation is here to stay or you wouldn’t be under a two-percent on the Treasury,” Jay explains.

“I think The Fed will push short-term rates up, the curve will continue to flatten, and at some point will become very flat to inverted. That will be the signal for the Fed that they’ve pushed rates up as far as they can.”

Thirty Capital CEO Rob Finlay points out that there’s nothing better for people who are looking to refinance long-term debt than to have an inverted yield curve.

Long-term or short-term loans for CRE investors?

Bryan recommends longer term loans. “If we look at the absolute level of rates, they are still ridiculously low, historically speaking.

“Right now, if someone can lock in five-year debt versus ten-year debt, the difference is only 15 basis points. Why not?” asks Bryan.

Rob notes that prepayment penalties will be less, and as the curve flattens the financial impact might not be as bad if investors run the analysis. Of course, this all depends on how much and how fast the curve flattens.

Keeping an eye on SOFR and LIBOR

The upcoming week will be interesting - it’ll be the first time the market has seen term SOFR rates that are going to be resetting over a Fed meeting where there's an anticipated rate hike.

Jay says LIBOR will start to tick up ahead of anticipated Fed tightening.

The week ahead will see inflation numbers released, which were being impacted by ongoing supply chain disruptions.

A sea change in the market

Analyst Jason Kelley foresees a sea change in the market, with inflation impacting the world, not just North America. Jason anticipates that interest rates are set to increase and stay high for some time to come.

Listen to the full episode for all the analysis, news, and views!

Short-term borrowers are being hit hard by market volatility right now. 

Commercial real estate investors looking for bridge debt will find that two to three-year debt is up a lot more than long-term yields, such as seven to Ten-year stabilized.

The Ten-year is still experiencing volatility, moving within a 10-point range in the last week.

Meanwhile, borrowers who usually look for longer term deals have asked Thirty Capital how they will be affected by Fed rate hikes which are on the horizon. 

Thirty Capital anticipates that the rate increase set for March will be a half basis point, not a quarter. 

Will the Ten-year continue to be range-bound?

Going forward, the question is whether the Ten-year will be range-bound at around 1.75, or whether the yield curve will flatten. 

Thirty Capital Analyst Bryan Kern says he believes the flattening is temporary, but that things will change once the Fed finishes tapering in March. That, along with a rate hike, will lead to a combination of inflation and growth. By the second quarter of the year, the Ten-year will start to move higher. 

Exiting loans with longer maturity

Thirty Capital Analyst Jeff Lee gives a thorough analysis of what’s happening on the CMBS side. And Thirty Capital CEO Rob Finlay points out that for borrowers looking for exit loans, it’s probably time to look for exit loans with a bit longer maturity, because the long-term money is fairly cheap.

Jeff adds: “We had some deals that were closing that had a month or two left to maturity, but they needed to be opportunistic to close because it made sense just to not test the markets,” he explains. 

“On the other hand, on the CMBS and agency side, we were defeasing loans with 2028, 2029 maturities, and these things were just closed a couple of years ago. So we have a very wide range, but we're still averaging out to a 20-plus year average that we consume.”

Policy-side ‘frozen’ right now

Analyst Jason Kelley says not a lot is happening with government policy at the moment, with the focus fully on the markets and interest rates.

On the length of term of loans, Jason says: “We've been talking for six months about the pendulum of ‘Do I do short-term debt or long-term debt?’.

“If the Fed does push up short-term rates in the next three or four meetings, then to me it's a hundred percent long-term. If the curve gets flat, it's the perfect time to put on long-term debt.”

The erratic performance of the past few weeks has seen a low of 1.30 to a high of 1.90; it was sitting at 1.72 at the time of recording this episode.

“There are so many questions around what the Fed is going to do, that’s affecting the short-term to two- to five-year sector,” explains Thirty Capital Analyst Bryan Kern.

“That's obviously going to translate into some volatility in the Ten-year sector,” he continues. “We may retest the 1.61 to 1.65 levels. But, generally speaking, I think we'll see that trend continue on up towards our 2% target here in the first quarter.”

In the coming week rates will be impacted by fourth-quarter GDP, along with inflation numbers and consumer confidence stats.

Long-term rates going up, short-term rates even higher

Bryan says the market’s question has changed from “Will the Fed hike in March?” to “Will the Fed hike 50 bps in March?”.

He doesn’t think the hike will be that high, explaining: “There are some people who expect five total hikes of 125 basis points. I don't think we'll see that. I think the median is 100 bps. But having said that, I think that's going to create some volatility.

“We will see a lot of volatility in that intermediate term three to five-year sector.”

For commercial real estate investors, this means that long-term rates are going up, and short-term rates will be even higher.

Ukraine, COVID, Fed tightening all impacting markets

Analyst Jay Saunders points out that global events are heavily impacting the markets right now.

“You've got the Fed pivoting from easy money to tightening. You've got Ukraine and you've got COVID. There are so many things right now pulling the market in different directions.

“It’s really hard to know where it's going to go, but I think you will see a lot of volatility.”

Term SOFR now adopted in real estate transactions

Thirty Capital is seeing pretty wide adoption of term SOFR. Notes Jay: “In fact, I'd say in the last three weeks, now we’re into three weeks of no more LIBOR, on the real estate side, I think exclusively we've seen one-month term SOFR on all the hedging products that we’ve executed.”

Fanny and Freddy use the 30-day in advance, and it's compound average in advance. With private lenders, it’s almost all term SOFR. The only place Jay is seeing a simple average SOFR is in the direct bank lending markets. We're seeing some of that.

Jay also discusses the differential between term SOFR and 30-day forward looking.

Confusion in the market around term SOFR

Thirty Capital CEO Rob Finaly points out that there is confusion in the market around term SOFR, not to mention that the conversion of LIBOR-based loans from borrowers has yet to happen.

Rob notes that issuers on the CMBS side and the CLS side have been having trouble trying to get people to adopt to term SOFR, because there is some arbitrage between interrelated Treasuries, term SOFR, and the 30-day compounded SOFR.

This week’s tip: Pay attention to the crypto market and the theoretical wealth some people have in crypto. It’s definitely set to be more influential in the coming months.

Be sure to follow Rob on Twitter and LinkedIn!