This year, the total amount of money borrowed and lent for commercial and multifamily mortgages is expected to drop to $733 billion, which is 18 percent less than in 2021 ($891 billion). This is what an updated baseline forecast from the Mortgage Bankers Association, which came out on July 19, says (MBA).
Multifamily lending alone, which is included in the total numbers, is expected to drop to $436 billion in 2022, which is 10 percent less than last year’s record of $487 billion. MBA thinks that borrowing and lending will pick up again in 2023, with commercial real estate lending reaching $872 billion and multifamily lending reaching $454 billion.
Space, equity, and debt markets are changing quickly, which is having a big effect on the number of commercial and multifamily real estate deals. After a record start to the year, we expect new loans to slow down in the second half of the year because rates are going up, there is still a lot of uncertainty about supply and demand for some types of properties, and people are worried about where the economy is going. Most of the commercial real estate market’s fundamentals are still strong, and many properties’ incomes and values have gone up a lot in the past few years. Because of these things, MBA thinks that people will start to want loans again in 2023 and 2024.
The size and timing of market changes will depend a lot on the direction of the economy, which is still unknown. If the economy goes into a recession, which would probably happen in the first half of 2023 if it were to happen, commercial and multifamily borrowing and lending would likely be even more limited.
MBA’s commercial real estate finance (CREF) forecast is based on our baseline economic forecast (link), which says that the US economy will continue to grow, but at a slower rate than usual, this year and in the years to come. It’s important to remember that this is just one way the economy could go.
The forecast says that inflation will go down, but will still be high, for the rest of this year. This is because some of the things that caused big price increases to slow down (like low interest rates, rising oil prices, and high consumer balance sheets), while others stay stubbornly in place (some supply-chain difficulties, increasing shelter costs). The baseline forecast says that price increases should slow down even more in 2023, and by 2024, they should be closer to the trend.
Slower-than-average economic growth is likely to make the labour market less tight, causing the unemployment rate to rise from an average of 3.7% in 2022 to 4.0% in 2023 and 4.50% in 2024. Note that members of the Open Market Committee of the Federal Reserve Board expect (and aim for) a long-term unemployment rate of 4%.
In the near future, short-term interest rates will go up. Longer-term interest rates will probably go up and down, but it is expected that slow economic growth and a return to more moderate inflation will be the main things that move them. We think that the average yield on a 10-year Treasury bond will be 2.9 percent in 2022, 2.8 percent in 2023, and 2.5 percent in 2024.
Based on where interest rates and mortgage spreads are expected to go, single-family mortgage rates should also go down, as should the rate at which home prices go up. For example, home price growth should slow from a high of 19% year-over-year in the first quarter of 2022 to between 2.4% and 2.3% in 2023 and 2024.
What does this mean for financing commercial real estate? In the last few decades, property values and changes in those values have been the most important factors in the number of sales and mortgages. Values, in turn, are driven by property incomes and by the capitalization (cap) rates investors use to value those incomes.
Cap rates can be seen to have two components, the risk-free yield and a risk premium. The risk-free yield is the return an investor can expect to receive in a government security or other extremely safe investment. Then, the risk premium is added to the return an investor wants for taking on the extra risk of a certain investment. The risk premium for commercial real estate can be seen in the cap rate spread.
In the past few months, the risk premiums for many different types of investments have gone up. This is because of both the increased risk caused by economic uncertainty and the general trend of competing yields going up. In the next few years, cap rate spreads are expected to go up, but they will still be lower than they were for most of the decade. When those cap spreads are added the 10-year Treasury yields, we anticipate a short, sharp jump in all-in cap rates.
At the same time that cap rates are expected to go up, net operating incomes are also expected to go up. There are still strong fundamentals in many parts of the commercial real estate market, such as low vacancy rates and rising rents. NOI changes will vary by property type but across the universe of commercial properties we project quarterly NOI growth will slow from the recent highs and will stay above longer-term averages. We use a NOI that comes from a mix of different sources and predict that quarterly growth will drop from an average of 3.3% in 2021 to 2.5% in 2022, 1.5% in 2023, and 1.4% in 2024. This measure of quarterly NOI growth averaged 0.9% in the 2010s.
When you put together the projected paths of cap rates and NOIs, you get a short, sharp drop in the value of commercial real estate (as the market adjusts to higher interest rates and cap rates), followed by a return to rising property values. As a result of the rise in cap rates, property prices could drop by 10 percent or more in 2022. In 2023 and 2024, prices could go up by 6 percent and 9 percent, respectively, as cap rates stabilise and start to go down and NOIs continue to grow.
Based on how things have changed over the past 15 years, our baseline economic forecast says that commercial and multifamily real estate lending is likely to drop by 18% from 2021’s record levels in 2022. Lending in 2021 was dominated by an outsized fourth quarter, while 2022 exhibited the fastest start to a year on record – meaning the model anticipates a significant fall-off in volume (relative to last year’s activity) the second half of the year.
As was already said, the economy could go in a lot of different directions from here, and the commercial real estate finance markets could react in a lot of different ways to those directions.
If the US went into a recession, which most likely wouldn’t happen until early 2023, the size and shape of the recession would determine how much commercial and multifamily lending and borrowing would happen. The most likely result would be a steeper drop in volumes than what is predicted here. The magnitude of any further declines would depend on the degree to which a downturn does or does not impact property incomes, as well as any impacts on investors’ valuations of those incomes through cap rates. Different things happened during previous recessions. For example, the 2001 recession had a bigger effect on NOIs and a smaller effect on cap rates, while the 2007 recession had a smaller effect on NOIs and a bigger effect on cap rates. There are also possible paths in which the economy is stronger and the amount of borrowing and lending is higher than what we describe here.
