Brian Brady Interview

#1 – How would you define the current state of capital markets? And where do you see the market heading?

The rapid interest rate increase is making refinancing difficult because net operating incomes didn’t rise as rapidly as borrowing costs.  Thus, investors are finding that they have to bring cash to the refinanced loan rather than take cash out as they have for the past ten years.  Lenders are scrutinizing deals more carefully and pulling back from certain asset classes.  This contributes to the credit tightening cycle.

The Wall Street consensus is that Fed hikes are over.  Fed Chairman Jerome Powell insists that they aren’t.  An old investors maxim is “Don’t Fight The Fed” so I don’t understand why Wall Street is doing that today.  The Fed has to get Housing Costs (residential rents and/or home prices) down.  That component contributes to more than half the Core CPI increase-  If Housing Costs were contained, Core CPI would be at the Fed’s targeted rate of inflation.  What that means to me is that the Fed won’t stop until housing prices decline and residential rent growth is flattened.

In my opinion, The Fed won’t stop raising rates.  We could see a repeat of 2023 next year.

#2 – How has the commercial loan/finance market shifted in 2023?

Prices haven’t come down but the cost of capital increased.  That means investors have to bring more equity to purchase transactions.  Regional banks failed and some pretty smart people think there are hundreds at risk.  If we lose more regional/community banks, there will be less capital sources.

Combine that with a higher cost of capital and the surviving banks will cherry pick loans to fund.  There is a lot investment capital chasing certain asset classes but eventually, those prices will peak or decline slightly.

#3 – What common challenges do commercial real estate borrowers face in the current market? What about opportunities?

Capitalization rates aren’t widening (it’s the prices!) commensurately with the rising cost of debt.  Lower leverage means lower cash-on-cash returns.  At a certain point, investors might just sit on the sidelines.

Some asset classes are declining in value.  When the COVID restrictions hit, we all thought that retail was dead because of online shopping and office buildings were dead because of the work-from-home trend.  It looks like retail is coming back but office buildings are experiencing problems.  At some point, gutsy investors will look at the office buildings and say “I can lease that place up”.  If she buys it for the right price, she will set a “bottom” from which office building can bounce.

#4 – What are the top three trends to watch for 2023?

• Higher interest rates
• More bank failures/mergers which means less capital to lend
• A shift in focus to owner-user loans (SBA) by banks

#5 – What are banks or other lenders looking for regarding borrower profile and deal profile?

The stronger the borrower, the more leverage.  Lenders are looking outside of the traditional underwriting guidelines for experienced operators “expanding”.  Lenders are using income from other investments to augment the underwriting process to produce higher loan amounts.  An example of this would be an experienced gas station operator, buying another gas station.  Our lender considered the income from the existing business in the underwriting process, to get a higher loan amount.

#6 – Do you have any advice for borrowers in the current market?

Start early. If you speak with an investment sales broker about a 1031 exchange into another asset, you should also speak with a capital markets advisor about the loan you might get on the upleg property. You might be surprised at how creative we can be if you begin early. It’s impossible to fully underwrite you until you’ve identified a property but, if you know the limitations about what you can buy, you can make better decisions.

Consider equity partners for new property purchases especially if they are within your family or current industry.  Many investors are going to be cash poor until interest rates come back down and deals can be made if you have a strong equity position.  Partners are not ideal if you are used to going it alone but strong borrowing entities will have a negotiation advantage when premium assets have to be re-marketed at a lower price.