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11 Takeaways from MSCI Real Assets’ February 2023 U.S. Capital Trends Report

Recent MSCI data shows trouble brewing in the capital markets even before this month’s bank failures.

As investors in commercial real estate brace themselves for potential further troubles in the regional banking sector after the failures of Silicon Valley Bank and Signature Bank, a new report from data firm MSCI Real Assets points out the current situation should be seen less as an unexpected shock and more as a continuation of trends that were already evident in the market for some time. Even though MSCI’s February 2023 Capital Trends U.S. Big Picture report follows data that became available last month, before SVB and Signature failures, it shows that capital markets conditions have been tightening and some real estate loans seemed headed for distress even before those events came to pass. Here are some major takeaways from the report:

  1. Overall, capital flows into the commercial real estate sector, including property acquisitions, refinancings and construction loans, declined in the second half of last year, to $842 billion, compared to $1.2 trillion during the same period in 2021. That trend was driven by a 44% decline in property acquisitions and a 23% decline in refinancings. The volume of construction financings did rise by 9% compared to the second half of last year.
  2. With financing terms tightening and property prices declining, total investment sales volume in February registered a 51% year-over-year decline, to $26.9 billion. Over a 12-month period ending in February, investment sales volume declined by 25%, to $683 billion.
  3. In an environment where interest rates have been rising and the price of taking out new loans increasing, borrowing costs on outstanding property-level debt for funds tracked by MSCI/PREA U.S. AFOE Quarterly Property Fund Index rose to 4.4% in December 2022. The last time borrowing costs were this high was a decade ago, in late 2013, according to MSCI researchers.
  4. The good news is that most of the open-end funds tracked by MSCI/PREA don’t carry high leverage and, as a result, should be less vulnerable to market shocks. The funds’ gross debt averaged about 24.6% of their gross asset values.
  5. Throughout 2022, banks grew their market share of commercial real estate lending, accounting for 48% of new loan originations in the sector, up from 40% during the five-year period preceding the COVID pandemic. Regional banks, which currently seem the most likely to suffer serious aftershocks from SVB and Signature failures, accounted for 27% of originations, up from 17% previously. National banks, on the other hand, kept their market share of originations relatively steady, at 15% of the market in 2022 vs. 16% before the pandemic. Government agencies (at 18%), investor-driven lenders (at 13%) and life insurers (at 10%) rounded out the biggest originators of commercial real estate loans last year.
  6. On average, regional and local banks offered loan-to-value (LTV) ratios that were toward the higher end of the spectrum, at 66.4%--above LTVs offered by government agencies, CMBS lenders, national and international banks and life insurers. The two lender groups that offered higher LTVs in 2022 included investor-driven lenders (71.2%) and CLO lenders (74.4%).
  7. Regional and local banks also served as the biggest sources of lending for construction financing last year, with 29% of market share. In fact, by year-end, their share of new construction loan originations rose to 34%, as other lending groups pulled back on financing new projects, MSCI researchers pointed out. Investor-driven lenders came in second, with 23 percent of the market share in construction financing. That marked a reversal from pre-pandemic trends, when national banks were the biggest lenders on new construction.
  8. Breaking down construction lending by sector, regional and local banks financed 63% of originations on new hotel construction and 42% of originations on new seniors housing construction, far above other lender groups.
  9. There are approximately $900 billion in commercial real estate loans set to mature in 2023, and MSCI warned that in a tighter lending environment, some of the borrowers on those loans could face challenges securing refinancing. There are currently fewer willing lenders in the market than there were before, capital costs are higher and lending standards have tightened. However, a large share of the loans maturing this year involve CMBS, CLO and investor-driven lenders, accounting for roughly $400 billion of the total sum. For many bank lenders, loan maturities will be coming due in 2026 and 2027, when banks will account for more than 50% of all real estate loan maturities, according to MSCI’s tally.
  10. MSCI researchers did note an uptick in the volume of distressed assets in the market in the second half of last year, which reached $13.7 billion. Sixty-five percent of these distressed situations involved office and retail assets.
  11. However, MSCI highlighted the difference between the general profile of distressed assets in the aftermath of the Great Financial Crisis (GFC), when many otherwise healthy properties experienced financing issues and today, when the distress in sectors such as office often has to do with market-wide shifts in the demand for such properties. In the fourth quarter of last year, sales involving distressed assets represented 1.2% of the total investment sales market, according to MSCI. At about the same point in the recovery from the GFC, distressed sales made up 20.3% of the market. Today’s “sales of assets out of distress situations are different than in the past because of challenges that are more fundamental,” MSCI researchers noted. There’s still a question of whether “a further curtailment in the debt portion of the capital stack throw more assets with fundamental challenges out to the market? Or would lenders and current owners be pushing cash-flowing assets out to the market as they did in the aftermath of the GFC?”
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