Florida Market Update: November 4, 2024
If It Pencils…
Leading up to the September 2024 Fed rate announcement, many borrowers across Florida (and elsewhere) elected to pause on moving forward with financing. The reasoning was typically along the lines of, “The Fed is expected to lower rates by 50 bps. I’m going to wait to lock rate until after the Fed meeting.” While this seems logical, what may not be understood is that the Treasuries already have expected rate movements baked in.
Markets are generally efficient, and the Treasuries were already accounting for a 50-bps cut. In reality, what moves the needle are surprises. For example, if it was expected that the Fed was going to cut rates by 50 bps and they left rates the same, then we would have seen large movements upward in the Treasuries the day of the announcement. If it was expected that the Fed was going to cut rates by 50 bps and instead, they cut by 100 bps, we would have seen large movements downward in the Treasuries the day of the announcement.
Since the September rate cut announcement, the 10-Year Treasury has gone up nearly 60 bps from its 3.68% close on September 18th. Those borrowers who waited are now feeling the pain, especially those with acquisition financing or looming loan maturities that need to act. As a capital markets advisor, our general advice for borrower-clients leading up to the Fed’s meeting was that if the deal pencils today then do not wait.
So, what’s accounting for this 60-bps increase in the 10-year?
- Stronger U.S. Economic Data: the most recent release of consumer spending data was stronger than expected, which leads some to believe that inflation could stay above its target for longer than expected.
- Receding Rate Cut Expectations: there is now less confidence in further rate cuts; ultimately, bond yields get pushed higher.
- Increased Treasury Supply: the U.S. government has continued to issue more debt, thereby increasing the supply of Treasuries. This has contributed to rising yields.
CMBS and Life Companies as a Backstop
Most banks here in Florida remain – for the most part – in a holding pattern when it comes to new CRE loan originations. With the exception of existing relationships and loans that are accompanied by significant new deposits, loan approvals for more “transactional” executions are few and far between. Borrowers in Florida are holding their breath during the loan approval process. No longer is it a guarantee that once a term sheet is issued that a borrower can expect a formal loan approval and commitment letter to follow.
Where we’ve seen the gap being filled during this time of banking volatility is typically with Life Companies and CMBS. As a correspondent for 25 Life Companies, Largo has continued to see a steady flow of closings across most property types (including some suburban offices) through ten months of 2024. Sponsors that have been through the Life Company financing process appreciate the certainty of execution once terms are issued. Attractive features such as no deposits, no ongoing loan covenants, acceptance of some existing third-party reports, no requirement of surveys or zoning letters unless the title company asks for them, minimal requirements on SNDAs and estoppels, and very competitive pricing make Life Companies a highly desirable choice for many borrowers.
As a company, Largo’s share of CMBS closings is significantly higher in 2024 than in the few years prior. Often, borrowers are electing 5-year terms versus 10-year terms in anticipation of lower rates at some point in the near future. Additionally, nearly all CMBS quotes nowadays are full-term interest only. 5 years is generally not long enough for a loan to amortize down, so CMBS lenders are issuing full-term IO on most 5-year deals. This provides the borrower with a fixed rate, better cashflow from the IO, and time to figure out next moves in five years.
Insurance and Interest Rates: A Festering Concern
Insurance remains a major issue for property owners across Florida:
- Acquisitions have died once borrowers receive insurance quotes because the numbers are no longer penciled in.
- Other borrowers have elected to sell properties once renewals came due because of the exponential increase in premiums.
- Florida’s intense hurricane season also did not help as we witnessed mass damage and destruction with first Helene and then Milton less than two weeks later.
As far as interest rates, the volatility in recent weeks has forced some borrowers to be pencils down until some level of normalcy and consistency returns to the market. Pro forma assumptions for development projects become more difficult when sponsors cannot determine accurate projections for valuations and cap rates upon exit.
The U.S. presidential election is another contributing factor to market volatility. Many buyers are electing to wait until after the election to move forward on deals, which has slowed down transaction volume. As the election comes to a close, it’s the hope that markets will return to some level of normalcy. What that normalcy looks like is yet to be determined.
