Private real estate credit has experienced heavy investment flows aided in part by record levels of property trades and ultra-low interest rates. Meanwhile, inflation has moved beyond the initial transitory characterization into a period where the financial markets are significantly concerned about its containment. In response, the Fed has switched from quantitative easing (QE) and near zero rates to quantitative tightening (QT) and raising shortterm rates. The end goal is to reel in inflation without putting the economy into a recession.
Now that short-term rates are increasing, the level of Secured Overnight Financing Rates (SOFR) will have a more meaningful role on the risk assessment of loan opportunities. With near zero interest rates, an asset’s ability to generate enough cashflow to pay debt service while the sponsor executes its business plan (renovations, repositioning, lease-up, etc.) generally penciled out with little concern for potential interruption. In this new higher short-term rate environment, floating rate lenders will need to spend additional time on an asset’s projected cashflows to gauge the potential reliance on the sponsor to infuse additional equity in order to “carry a loan” or make shortfall payments, should one occur.
EXHIBIT 1: Daily SOFR forward curve
Chatham Financial, 21 March 2022