Waiting for the Increase in the Cost of Capital

WASHINGTON, DC—It is hard to be glum about the findings from the Commercial Real Estate Finance Council members annual survey released this week. Across the board, the results pointed to robust markets ahead for borrowers, from CMBS to private equity to GSE finance and bank lending.

There is this however: the survey hinted at an expected increase in the cost of capital, albeit it won't be happening in 2015. Rather the pieces are moving in place this year for these costs to start to rise beginning in 2016, CREFC president and CEO Stephen M. Renna tells GlobeSt.com. By how much will depend on how events shape up over the next twelve months.

The "why" though is already clear. "Regulatory change from various sources is going to impact the cost of capital," he says.

One unknown will be the capital requirements under Basel III, a complicated set of international rule-making currently underway.

"Basel is in various stages of implementation, so it is hard to say exactly what the end result will be," Renna says. "At its simplest explanation, the rules will call for banks to require more capital reserves held and liquidity held for various types of loans."

The more capital banks are forced to hold in reserve, the more expensive the loans will become. Word on the street is that when it is all said and done Basel III's capital retention for commercial real estate loans will be as much as 25%.

"Whatever the amount winds up to be," Renna says, "it will certainly be substantially more than it is today." Risk retention under the Dodd-Frank Act is another area to watch. These rules were finalized in October 2014 and in many respects avoided the most onerous terms that had been proposed at one point or another. Still the story is not entirely over as these rules will probably be tweaked here and there throughout the two-year implementation period--although certainly with no significant changes.

There are still major questions, though, about the rules that the regulators cannot answer, such as who will step up to help the B piece participants assume the new levels of risk retention. "The rules call for them to retain twice as much as they do now," Renna says.

"We still don't know where this additional capital is going to come from. Who will these investors be and what will be their risk appetite and profile? All of this is what the market has to determine over the next year."