CRE Capital May Not Be as Available as You Think

Access to capital for CRE properties remains surprisingly elusive, but we expect it to return to pre-pandemic levels soon in most sectors.

Peter Muoio

Many property types have held up despite apocalyptic forecasts, while the balance sheets for top lenders have swollen, as deposits have grown and stimulus money has filtered through the economy. For debt capital, the cratering of interest rates should also drive capital into investments like CRE.

Yet, according to the latest data from RERC, a SitusAMC company, the availability of capital is still below pre-pandemic levels, while discipline has stagnated. In an environment where many lenders are flush with cash, the nature of the recovery has bifurcated capital availability and sidelined lending until uncertainty lessens for struggling property types.

Institutional investors—who are surveyed each quarter by RERC—reported a significant increase in the availability of capital in the first quarter of 2021 from the previous quarter. Even so, and perhaps counter to what one would assume, the survey respondents rated availability as still well below pre-pandemic levels. Availability is near the levels we saw in the early 2010s, when the economy was also recovering from a severe shock, and the acceleration of the respondents’ gauge of capital availability mirrors that recovery.

The same trend emerges for debt and equity capital separately. Institutional investors had rated capital availability highly for years before the pandemic as ultra-low interest rates spurred the capital buildup. As the economy heats up, we expect investor skittishness will dissipate, accompanied by a return to pre-pandemic levels for debt and equity capital over the next couple of quarters.

Underwriting discipline was relatively steady quarter over quarter, but survey respondents rated it as the least disciplined in almost five years. We are not overly concerned about the survey respondents’ low rating for underwriting discipline because it was still rated above average and much higher than it was prior to the GFC. Underwriting standards have deteriorated for both debt and equity capital since the pandemic began and are among the least disciplined since RERC began collecting these data in 2014. Even so, investors still rated equity and debt discipline as above average.

The ongoing bifurcation

One of the major reasons why we are not yet seeing capital availability returning to pre-pandemic levels is that availability and underwriting standards are varying greatly by property type as the bifurcation intensifies. With investors clamoring to get into the industrial sector, underwriting standards have become increasingly aggressive with above-inflation market rent growth assumptions on top of investment-rate compression. We expect to see increasing in-term rent bumps in the sector—including over 3 percent annual rent growth in Southern California markets. Apartment capital availability and underwriting appears to be back to pre-COVID-19 levels in most markets, but there is very muted interest in retail, except for grocery-anchored neighborhood and community strip centers. Investors are hesitant about the office market because of continued uncertainty about how many employees will keep working at home; the mismatch of buyers and sellers has made it difficult to accurately analyze market conditions.

Another reason why capital is remaining on the sidelines is the lack of distressed properties. The more than $250 billion in capital accrued over the past year to chase these properties has not been significantly deployed. Capital that has been deployed is competing for a narrow slice of properties, almost negating any discount purchases, according to JLL. Still, opportunistic funds, including new REITs, have been formed to take advantage of the downturn. But traditional lenders have not yet returned to the market in any significant numbers. They are still cautious, worried about the loss of tenants, rental revenue and their ability to service their debt. Debt capital is available through debt funds but at low leverage and high interest rates.

Peter Muoio, Ph.D., is a senior director at SitusAMC Insights.