Credit Corner: What’s Driving Deals Today?

Welcome to the first edition of the Offset Credit Corner.

Through our capital partner relationships, we have a window into how leading credit investors think about deals, underwrite risk, and read the broader economy to make investment decisions.

We see shifts in what lenders are becoming more comfortable with, where they’re pulling back, and how those changes are influencing underwriting, often before they show up in broader market data.

This time, we’re looking at how the recent move in Treasury rates could reshape credit spreads, cap rates, property values, and financing proceeds–and where flexibility around existing debt can still create a path to getting deals done.

The 10-year Treasury has moved sharply higher over the past couple of weeks, rising from just under 5.00% in mid-September to above 5.25% at the end of the month, marking the highest level in over two decades. For borrowers, it’s a reminder that credit spreads, which in recent years have been the primary focus, are only half of the interest-rate equation.

While benchmark CRE spreads have remained mostly unchanged thus far, we are starting to hear anecdotally of lenders and back-leverage providers gapping out pricing as higher rates begin to impact funding costs and risk appetites.

This rise in rates is beginning to impact debt service coverage, particularly when modeling permanent takeout scenarios for bridge loans. As a result, some deals that a month ago were LTV or debt yield constrained are now DSCR constrained. That shift is making the exit increasingly important to how we size loans today. At the same time, we believe the move in rates may be just the beginning of a broader reset in valuations.

Historically, cap rates have tended to move in the same direction as the 10-year Treasury, although not one-for-one. Since 1995, a 100-basis-point move in the 10-year has corresponded with roughly 40 to 80 basis points of cap-rate movement, depending on property type.

That means a sustained move higher in Treasuries can put upward pressure on cap rates—and downward pressure on values—even if the adjustment doesn't happen immediately.

With the 10-year Treasury now around 5.36%, cap rates below that level imply a negative going-in spread to the risk-free rate. Investors may still accept that for assets with strong growth prospects, tax advantages, or other compelling attributes, but the hurdle for justifying that pricing has moved considerably higher.

NCREIF data over the past year shows transaction cap rates on properties that have actually sold generally running around 100 basis points higher than appraisal cap rates.

With fewer trades closing, there are fewer recent comps to work with. That's creating a wider gap between what an owner believes a property is worth, where it appraises, and what a buyer would actually pay for it today. The recent move in interest rates could put further pressure on that disconnect before appraisals fully catch up.

We're seeing that gap show up directly in financing conversations. An owner may still be working from the appraised value, while buyers and lenders are underwriting to what the market would actually support today.

Before sizing the financing, we're pressure-testing all three: the owner's expectation, the appraisal, and where the asset could actually trade today. That gives everyone a more realistic starting point for proceeds.

LTV is usually one of the first things brokers ask about, but it's only part of how we're sizing a loan.

In recent years debt yield was often the limiting factor. With rates moving higher, DSCR is increasingly becoming the guiding constraint–particularly when we look ahead to the permanent takeout.

We're underwriting loans that we expect to be refinanced in two or three years, often by an agency or another permanent lender. So we're looking at what that takeout is likely to support, not just what the property can carry today.

A deal can work on leverage and debt yield and still fall short once we underwrite DSCR at exit. Looking at all three from the start gives us a much better indication of where proceeds are actually likely to land.

Both borrowers and lenders are adjusting to the realities of today’s market. When a property doesn’t support enough new debt to pay off the existing loan in full, that doesn’t necessarily mean the conversation ends there.

Existing lenders are putting more pressure on borrowers to pay off loans, while also showing a willingness to consider discounted payoffs. At the same time, borrowers are increasingly prepared to bring additional equity to the table to get a deal done.

By the time these deals reach us, the borrower has often already had that conversation with the existing lender and has a clear picture of the gap. That gives us something concrete to work with and can open up structures that wouldn't be available in a straightforward refinance.

A gap between loan balance and value isn't automatically a dead deal. What matters is whether the borrower and existing lender have enough flexibility to bridge the gap and make the new financing work.

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If you're working through one of these situations, send it our way. We're always happy to take a look at the deal, talk through where we think proceeds can land, and see whether there's a structure that works. Reach out to info@offsetcap.com to talk about your deal.

About Offset Capital

Offset Capital is a private credit lender providing $10MM–$50MM senior secured financing across the middle market, with a focus on downside protection and certainty of execution.

Get in touch with the Offset Capital team at info@offsetcap.com or view Offset Capital’s lending capabilities here.