CRE lenders get back to credit basics as the Fed hikes again

Commercial real estate lenders are underwriting into a federal funds target of 3.75% to 4% after the Federal Reserve raised rates a quarter point on Sept. 16, its first increase since July 2023, Commercial Observer reported. The 10-year Treasury yield crossed 5% on Sept. 14 and hit its highest level since 2007 a day later.

Fed governors paused at the Oct. 28 meeting, but the September dot plot signaled one more hike before the end of 2026 and a funds rate near 4.1% through 2027. Jai Agarwal, president and chief operating officer at Dwight Investment Management, an affiliate of Dwight Capital, told Commercial Observer that elevated rates should bolster appeal for its bridge loan platform, since borrowers are more hesitant about locking in long-term CMBS debt priced off the day's Treasury rates.

For allocators comparing CRE debt funds, the diligence question moves to the floating-rate share of a manager's book and to how each loan refinances if the funds rate holds near 4.1% through 2027. The report's point that lenders are scrutinizing sponsors, properties and business plans more sharply suggests proceeds will be tighter for weaker sponsorship, which is the kind of detail that shows up in fund-level loan-to-value.

"We've become more defensive in our approach," Agarwal told Commercial Observer. "With the volatility we've seen, we're running more scenario analyses to make sure every deal holds up across a wider range of rate and valuation outcomes."

Steve Caldwell, head of large loan CMBS at Wells Fargo, told the outlet that expectations of elevated rates mean it is "back to basics on credit work," with more attention to valuation, leverage and property sectors with dependable cash flow. He said much of his time goes to judging where investors "will continue to have appetite" for "collateral quality" and its "resilience through cycles."

The higher-rate climate is making lenders more selective about where they deploy capital, the report said, with sharper scrutiny of sponsors, properties and business plans. According to Commercial Observer, the FOMC under new Fed Chair Kevin Warsh is carrying a hawkish stance into 2027, echoing the posture Jerome Powell set in early 2022.