Susan Mello joined Walker & Dunlop, one of the nation’s leading commercial real estate finance firms, a year ago as executive vice president and group head of capital markets. Its team consists of 96 originators, dedicated to finding financial solutions across the entire capital stack, for any type of property across the country. With so much going on in the past year, Partner Insights decided to reach out to Mello to find out more about his key accomplishments and observations during this time.
Trade Observer: You‘come celebrate your first anniversary as Head of Capital Markets at Walker & Dunlop. What are some of the most notable national trends you’ve seen in financial markets over the past year?
Suzanne Mello: There are a number of different trends, but the most striking has been the rise of alternative, or non-bank, lenders. If I look at Walker & Dunlop’s funding sources from 2019 to 2021, including GSEs, HUDs, etc., the funding companies have gone from around 14% of our volume to around 37%. Current trends in 2022 indicate that it is even higher, although we are seeing some slowing in activity over the last 45-60 days. Another trend has been a pivot towards floating rate debt versus fixed rate debt. In 2019, around two-thirds of the debt we placed was fixed rate. In 2021, unsurprisingly given the sharp decline in interest rates during the pandemic, it was two-thirds variable rate, virtually the reverse.
What explains the growth of these alternative lenders?
The shift to investor-focused lending is the result of more money being allocated to commercial real estate, which has become a proxy for fixed income investing. Falling interest rates are putting increased pressure on fixed income investors, especially those, such as pension funds, who are worried about meeting return targets. Investors could turn to real estate debt in their search for yield without significantly increasing the risk profile of their investment portfolios.
With so much uncertainty in the market right now and large moves in Treasuries on an almost daily basis, how does all of this affect the way you advise clients?
As trusted advisors to our clients, we don’t just focus on economics, we talk to our clients about what they are trying to accomplish and the certainty of execution. Whether we place debt and/or equity, we know our funding sources and seek to match our clients with funding sources that understand and value the relationship side of business. In a volatile market environment where you feel like you are walking on quicksand, our mission is to find solid ground for our clients. It is in these uncertain times, when cash is less available, that we can truly deliver value to our clients.
Considering all these factors, which asset class currently presents the best opportunities and why?
Over the past two years, a lot of capital has been invested in both multifamily and industrial; you could make a large bet on these sectors and, given the macroeconomic and demographic tailwinds, these investments did not carry much risk. While we believe the tailwinds will continue to support investment in these sectors, going forward investors will take a closer look at the properties themselves, as opposed to just the real estate sector. For example, our team closed a $34.1 million financing for Xebec in February of this year in Chino, California, where competition for space is fierce. At the time of closing, average rental rates in the region had increased by more than 10% compared to the previous 12 months. This product, this location and this sponsorship are always very attractive.
New online retailers and brick-and-mortar retailers continue to lease space to cement their position in the hierarchy of e-commerce platforms, like this 315,320 square foot, 36 clear foot Class A industrial building located on approximately 14 acres in Chino, California.
But as greater certainty is needed moving forward with capital deployment, we will see investors become more discerning about the specific assets they invest in, seeking those that offer relative value.
What’s more worrying about commercial real estate right now, inflationary pressures or rising interest rates?
I don’t believe it’s a single thing, it’s a confluence of events. Inflationary pressures, caused at least in part by supply chain issues, have driven interest rates higher. These issues, along with the geopolitical environment, COVID, etc., are behind the huge uncertainty we have in the market today. For example, if you are a developer, not only are you feeling pressure due to rising costs due to labor and supply constraints, but now you also have interest rates and increased debt costs that put upward pressure on your budget. For sponsors acquiring assets today, unless and until we see cap rates rise (and we’re in some places/assets), it’s going to be how far they can push their rental growth assumptions. With this environment of low cap rates for certain asset classes and rising debt costs, you have negative leverage. To get your deal done, you often have to rely on heavy rent growth assumptions, and that’s where the pressure comes in, because there’s a question of how long it will last before you go back to more normalized growth.
What would you describe as Walker & Dunlop’s greatest strength compared to its competitors?
We’re a relatively small company compared to some of our peers, but it’s our continued investments in people, brand and technology that have fundamentally changed our competitive positioning within the commercial real estate industry. We provide a highly personalized experience for our clients while delivering the best financing execution our clients need and want.
We also have a diverse platform, with a wide variety of solutions, whether third-party or proprietary, both as a lender and advisor. In 2021 alone, we secured deals from over 350 sources of capital. This access and experience allows us to be practical and creative when it comes to managing complex financial structures for our clients.
Looking back on your first year, what Walker & Dunlop accomplishments and progress have you‘are you most proud of the past year?
Although we’ve had a debt brokerage platform for a number of years, Walker and Dunlop is well known and has established itself as the nation’s premier agency lender, ranked #1 Fannie Mae lender and No. 4 with Freddie Ready Mac. Our core debt business was dominated in 2020 by our GSE loans, and our capital markets advisory business declined as lenders took stock of the impact of COVID. However, in 2021, GSE loans were down and our debt advisory business was able to step in and offer financing solutions to our sponsors and ensure the liquidity of their assets. We knew we needed to diversify our business, and our ability to pivot and bring the best solutions to our clients was exemplified by our 2021 business. In our debt advisory business, we increased our volume of transactions of approximately $9 billion in 2020 to $27 billion in 2021.
What big trends do you think capital markets are most likely to see in the coming year?
I think we will continue to see various sources of capital, including more “retail” capital, as distribution channels evolve and reach even more individual investors. Historically, it was investors who had no access to institutional-grade real estate unless they invested in public REITs. With the rise of a new class of non-traded REITs and crowdsourcing platforms reaching more of the population, the result is that more money is flowing into private real estate.
I also think that we will continue to see sub-sectors rise in the large real estate sectors such as life sciences assets or medical practices. In residential, it’s no longer just about traditional multi-family housing, but investors are turning more to niches such as manufactured homes, single-family rentals or build-to-let (BFR) assets. Our team has been at the forefront of the BFR trend, closing over $2 billion in deal volume and currently has an active pipeline of $5.6 billion. One such development was recently completed by our Phoenix team who arranged a $26.3 million financing for Seneca at Southern Highlands in Las Vegas, with a luxury development expected to close in May 2023. Final terms of the loan included a three-year term with interest-only payments at a very competitive rate.
Seneca at Southern Highlands, a 50-unit luxury rental community to be built in Las Vegas.
As more capital flows into the space from alternative sources, investors will seek the increased return they perceive can be earned by investing in these less traditional assets.
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