SoCal Capital Markets Update: Low Interest Rates Thaw Out A Frozen Market

In the first months of the year, the coronavirus rattled capital markets, throwing real estate investors into uncertainty. Through the spring, borrowers who were hoping to transact in Southern California chose to wait on the sidelines to see how the pandemic would play out.

But recent trends suggest a return of capital and transaction volume for the remainder of 2020. Low interest rates are driving buyers back to the market to buy, sell or refinance. Investor confidence is returning, boosting sales in SoCal markets that have been stalled for months.

"April and May were very slow, mainly because investors wanted to see how things progressed," said NorthMarq Multifamily Managing Director Shane Shafer, who leads the firm's Southern California investment sales practice. "More recently, we have seen improving operations and increased confidence in the market, giving investors more comfort in understanding price discovery."

A Resilient Market With Improving Fundamentals

In the last two months, NorthMarq's Southern California team has listed nearly $200M of multifamily assets, more than triple what the team listed from March to May.

In the early stages of the pandemic, only a few life insurance companies remained active in Southern California. As the capital markets have settled, most are visibly back in business and competing with Fannie Mae, Freddie Mac and HUD on interest rate and term length, and have begun offering new programs to compete with the agencies, said David Blum, senior vice president and managing director with NorthMarq Debt & Equity.

Shafer added that he has seen a new willingness from SoCal investors to look beyond their usual geographic and asset class horizons. 

"Most of these buyers are coming from LA County, but all SoCal investors want to have a diversified portfolio and take advantage of some of the areas that are rebounding faster and showing better fundamentals," Shafer said.

One market in particular that is attracting attention is the Inland Empire, where an industrial boom is underway thanks to a spike in e-commerce demand as well as growth in the healthcare sector.

Despite discouraging unemployment numbers nationwide, investor confidence remains high in SoCal real estate, especially multifamily.

"Buyers feel that the Southern California markets will be resilient and bounce back," Shafer said. "As more businesses reopen, areas such as Orange County, San Diego and the Inland Empire will continue to show great long-term fundamentals driving buyer interest and capital to these locations."

Stable Financing Leads To Long-Term Bets

Along with strong investor sentiment, low interest rates are boosting faith in SoCal real estate and inspiring investors to make long-term investments. Recently reduced floor rates tend to range between 2.55% to 3.25% depending on the deal, according to Joe Giordani, senior vice president and managing director at NorthMarq.

"The yield curve is essentially flat at the moment, which makes longer-term debt very attractive," Giordani said. 

That cost of capital is likely to stay low for a long time. Treasury bond yields hit record lows in the last month, and Federal Reserve Chairman Jerome Powell stated at the June Federal Open Market Committee meeting that the Fed is not even considering raising rates in the near future. That level of clarity on interest rates has given investors the confidence to make longer-term bets with the knowledge that the government will be doing what it can to help borrowers, Giordani said.

Historically, when credit tightens, loan executions from the Federal Housing Authority and HUD become more appealing for developers and investors, said Blum, who is currently working on two HUD deals. The Fed also pledged to continually purchase agency mortgage-backed bonds, which the multifamily industry took as a strong vote of confidence in the multifamily sector. As a result, multifamily financing continued even through the height of early pandemic uncertainty.

Maximum leverage loans offered via FHA and HUD executions have led to a surge in pipeline volumes for 221d4 construction-perm loans and 223f refinance loans, Blum said. Banks that pulled back on construction financing leverage, along with recent changes of the stabilized seasoning requirements for 223f refinances have also increased the appetite for these sorts of loans.

Commercial mortgage-backed security lenders and debt funds felt a pinch as capital flow was restricted earlier in the year. But there are encouraging signs for these lenders in the form of successful securitizations of newly issued CMBS and CRE-collateralized loan obligation bonds, which have allowed those lenders to quote and close new loans across a wide array of asset types.

Keeping the CMBS and CLO markets functioning will be crucial to providing capital to keep retail and hotel assets afloat, Giordani said, as many lenders are temporarily pulling back on hotel and retail loan originations.

"Capital availability has paralleled the pandemic's effect on different assets. The more affected a sector is, the more difficult it is to find capital," Giordani said. "Understanding how various lenders are structuring debt is important for developers and investors as they consider their own business models and how to take advantage of distressed opportunities."

While the market slowdown was punishing for many players in SoCal's real estate market, the low cost of capital has allowed for a new normal to materialize, with investors feeling secure in long-term buys. And the good news, the NorthMarq team agreed, is that recovery builds on itself: the more investors feel stable, the more stability they create.

This feature was produced in collaboration between the Bisnow Branded Content Studio and NorthMarq. Bisnow news staff was not involved in the production of this content.