It's like reading tea leaves, but through extrapolation from 300-plus loans
In interesting times, sometimes the mundane can take on a more significant and telling form. Digital CRE platform Lev recently examined a sampling of 300-plus loans to achieve trend data related to today’s mercurial market, sharing its findings with Mortgage Professional America.
Three takeaways from the data examination mirror the volatility of today’s market: Demand for permanent loans is tanking; demand for transitional loans has seen a substantial increase; and construction loans are experiencing a spike in demand.
“Effectively, as we see this rising interest rate environment, the real thing we’re trying to highlight is the juxtaposition of permanent versus transitional loans,” Lev’s senior associate, business operations, David McBroom explained during a telephone interview with MPA. “Permanent being loans that are permanent acquisitions, or permanent refinancing loans that generally have longer maturities, and transitional loans that can be some sort of a bridge deal or construction loan that generally have shorter maturities in terms of how long they’re actually outstanding.”
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“A big thing we’ve seen from the data that we’ve been generating just from the variety and plethora of borrowers and lenders we communicate with on a daily basis through our technology, investors and property buyers – not as much property owners but really property buyers, have become more sensitive to the rapidly changing and incredibly uncertain interest rate environment,” McBroom added. “What that does is highlight a very specific macroeconomic, fundamental relationship between interest rates and prices. With the Fed raising the Federal Funds rate and mortgage rates becoming more expensive as well, we kind of see a pullback or decrease in the actual prices of assets underlying these loans themselves.”
Another eye-opening finding lies in the realm of pricing amid a rising rate environment: “As the rates rise, the borrower demand is affected because cost of capital, cost of debt, becomes a lot higher and thus they kind of need lower prices to justify the amount of leverage they want or the actual loan a lender is willing to underwrite,” McBroom said. “We haven’t seen a drawback or drawdown of these prices. We haven’t seen them downwardly adjust to satisfy this new equilibrium, and as the demand has been shifted necessarily by the rising rate environment. There does have to be some balance on the pricing side, on the buy side, so there is this new equilibrium. We expect that if there is a lag between these prices and these rates – which, from what we’ve seen, there has been – that there’d be a pullback of demand for new permanent loan origination.”
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The sampled data bore some of this out. As a share of total loans demanded, demand for permanent loans fell by 7.8%, while demand for permanent refinance loans fell by 17.1% in the second quarter of this year when compared to the first quarter, according to Lev’s findings. In the data extrapolation, it appears to yield signs that investors and property owners have become more sensitive to the rapidly changing interest rates environment as evidenced by the negative correlation between interest rates and stabilized transactions, McBroom noted.
“Really what a lot of investors are doing is placing their speculation down the road into the future,” McBroom said, noting the delay is driven by continual rises in interest rates coupled with uncertainly into what the Fed might do next. “Locking in more favorable rates for a couple of years so the next time they estimate a decision on what the path forward is, they have a better understanding of how the actual macroeconomic environment is shaping out.”
Conversely, demand for transitional loans have seen a substantial increase, according to the findings. The share of transitional deals has almost doubled, increasing by 41.2% since the second quarter of this year compared to the first quarter relative to other loan types – due in large part to a disequilibrium between prices and rates.
“We have seen significant rate increases with little effect on prices,” McBroom said. “This makes it harder for stabilized/permanent deals to pencil out, while transitional deals become more attractive in a speculative market.”
Lev has also tracked a demand spike for construction loans – a 40.7% increase in construction loans as a percentage of total loans demanded in the second quarter as compared to the first quarter. McBroom noted the demand spike identified is relative to the other loan types. While somewhat expected, the trends being seen today could presage future scenarios, he suggested.
“If you think about it, construction loans have always been generally increasing at the same rate they have been the past couple of quarters,” McBroom said. “They just haven’t been as affected by the negative headwinds and interest rate environment.”
It’s future market scenarios – shaped by developments occurring today – that developers may want to brace for: “Really what we want to look for in the next 18 to 24 months is how the construction loans – the development of properties for land firms that don’t necessarily have a buyer already lined up – how they’re actually able to offload their physical assets. From a cost of capital standpoint, all of this makes sense for construction firms. What may not make sense is the actual supply and demand equation they’re going to end up with in two years when they go to sell the asset. It could indicate a lower price than expected, thus leading to lower returns, or lower prices, or lower profit margin.”
Lev uses AI and machine learning to automate the CRE lending process. As a result of such cutting-edge tools, Lev officials boast of their ability to close loans up to three times faster than traditional brokerages. The fintech startup officially launched its direct commercial real estate lending arm, Lev Lending, in February.
