Finance N Illinois

Financing outlook for 2019: No major disruption, fundamentals remain key

Financing outlook for 2019: No major disruption, fundamentals remain key,ph1
What will the availability of investment and development financing in Chicago look like in 2019?
Financing outlook for 2019: No major disruption, fundamentals remain key,ph2
David Fetter, regional senior manager for Commercial Term Lending, Chase.

With the mid-term elections now past us, there are fewer unknowns for commercial real estate financing going into 2019. Fewer, but certainly not zero as issues like a brewing trade war, interest rate hikes and Illinois’ turbulent political situation all have the power to affect the availability of CRE funds.

With that in mind, what will the availability of investment and development financing in Chicago look like next year? While a high velocity of transactions and new deliveries have become the norm over the past six or seven years, the bull market has to slow down at some point.

“The commercial real estate financing outlook for 2019 may moderate,” said David Fetter, regional senior manager for Commercial Term Lending, Chase, “however we could see a similar range of production to 2018 as long as interest rates maintain a narrow continuum and the market continues to absorb the new construction.”

Many in the marketplace are wondering how those increasing interest rates will affect the number of financing requests—as well as how funding originators will respond. In the end, however, any effect would depend on the specific transaction, structure and the amount of interest rate increase.

“In regards to the equity market, rising rates can impact acquisitions as cash-on-cash yields get reduced, impacting the volume of transactions in the market,” Fetter said. “The debt side may also experience changes, as higher rates impact debt coverage and decrease loan dollars. This can potentially affect the volume of transactions in the market in the near term, but we do not expect a huge shift at this point.”

The Fed has been transparent about its rate hikes this past year and there’s no reason to believe that will change over the next four quarters, allowing investors and developers to bake any future changes into their projections. In fact, actors within the government, as well as lenders and borrowers in the private sector, have shown a lot of restraint.

“We’re also seeing a continued abundance of capital on both the debt and equity side,” Fetter said, “which has remained fairly disciplined to date.”

While the bounce-back from the Great Recession has led to one of the greatest bull markets in U.S. history, there’s no doubting that the bear is coming. According to Fetter, a decelerating development cycle and issues unique to Chicago and Illinois may lead to a moderate pace of financing and transaction activity going into 2019.

“Overall, the real estate market is experiencing more headwinds, including city and statewide challenges, continued delivery of new supply into the market, increasing costs and expenses to build and manage properties, all impacting rental growth and the pace of financing and transaction activity,” Fetter said. “Most commercial real estate fundamentals remain positive. At the end of the day the key impact to the market is going to be continued job growth.”

Construction deliveries have left some new space unleased in the Chicago market. One asset class where this hasn’t been as much of an issue is in multifamily, particularly Class A product within the urban core. The question remains if this will continue, and how other classes and submarkets will perform in 2019.

“The overall multifamily landscape in Chicago continues to perform well. Certain price points and unit sizes are experiencing challenges today, tempering some of the rental growth in the market,” said Fetter. “Class A properties absorbed well this year and, given the ongoing delivery of new units, we’ll see how that continues in 2019. It’s largely dependent on the rate of local employment growth. We remain optimistic on the downtown neighborhood markets, especially as it relates to the core, stabilized B-C properties.”

There’s no talking about multifamily in Chicago without also mentioning the driving trend of the past few years: condo deconversion. As more people start to take notice, is that a sign that the bubble is ready to burst, or will major deconversion deals continue to occur as the market moves into a new year?

“It all depends on the fundamentals of each deal and heightened seller expectations,” Fetter said. “As these deals continue to get done and the market becomes more educated, this could lead to fewer opportunistic buying opportunities.”

As the calendar flips over into 2019, factors such as political instability, oversaturation and interest rates create questions about financing availability within CRE. On the other end of the scale is the economic strength of Chicago, which has buoyed the market in spite of these challenges. The determining factor, then, will continue to be fundamentals unique to each particular deal