Over the past year, the economy has grappled with higher interest rates that have tightened lending conditions. The collapse of SVB Financial's Silicon Valley Bank and Signature Bank made a tight lending market even tighter.
One segment of the economy seeing this play out is commercial real estate. Investor concerns have turned to commercial real estate because small banks extend most of the loans to the sector. This pullback in funding has made it more difficult for those who are refinancing to get a loan at a reasonable interest rate.
Walker & Dunlop (WD 0.10%) is looking to take advantage of this. Walker & Dunlop is the largest multifamily housing lender and investor in the U.S., which makes up a sizable amount of the commercial real estate market. The company has struggled as property transactions come to a screeching halt. However, it has the liquidity and position to capitalize on a nearly half-trillion-dollar opportunity. Here's how.
Commercial real estate transactions are way down
It's been tough for commercial real estate companies, which have seen big drop in transaction volume compared to the first quarter of last year. Last March, the Federal Reserve raised interest rates for the first time following the pandemic. Since then, it has raised the fed funds rate (the overnight lending rate among banks) from roughly 0% to 5.25%.
Rising interest rates have been a headwind for the business and explain why Walker & Dunlop's multifamily property sales volume fell by 46%. This is significant but is still less than the 74% decline in multifamily property sales across the industry, as reported by CoStar.
When all was said and done, Walker & Dunlop's total revenue declined by 25% while earnings per share fell by 63%. In response, the company is cutting employee headcount by 8% while reducing operating expenses in anticipation of reduced transaction volumes through year-end.
The slowdown presents Walker & Dunlop with an excellent long-term opportunity
Lower property sales volume has weighed on the company's results in recent quarters. The recent weakness in the banking sector has contributed to challenging conditions for commercial real estate.
According to the Fed, banks hold 60% of nonfarm, nonresidential commercial real estate loans outstanding, and small banks hold more than two-thirds of those. When Silicon Valley Bank collapsed, many other banks took a cautious approach to lending to ensure they had liquidity. Walker & Dunlop Chief Executive Officer Willy Walker said during the first-quarter investor call this month, "The recent banking crisis pulled banks out of the commercial real estate lending market almost immediately."
Walker sees the pullback in funding as a significant opportunity for the company. According to the CEO, a 5% to 10% pullback in bank funding to commercial real estate will open up the need for $225 billion to $450 billion in new capital. He said that Walker & Dunlop should be able to raise this debt through its fund management business and has a distribution network with 220 bankers or brokers nationwide to deploy this capital.
If the company can pull this off, it would be a significant driver of growth. Multifamily construction spending has taken off over the past decade, and experts expect strong trends to continue over the next several years.
Image source: Getty Images.
Before you invest, consider these near-term risks
The commercial real estate market will continue to face challenging conditions. We're still not in the clear on the banking industry. Not only that, but high interest rates continue to weigh on lending markets across the economy. These conditions could make it difficult for Walker & Dunlop to obtain the financing needed to complete its goals.
The company isn't too concerned about credit losses in its multifamily portfolio. Based on its experience during the Great Recession, it says that it would take a drastic increase in unemployment to affect its portfolio adversely.
CBRE Group, the world's largest commercial real estate company, expects transaction volumes to continue to face pressure through the end of this year. However, it expects valuations for multifamily properties values to fully recover over the next two to three years -- which would be twice as quick as the recovery after the Great Recession.
A solid stock to add to over time
Walker & Dunlop is a top lender through government agencies Fannie Mae and Freddie Mac. It has also expanded its footprint into affordable housing, which has become increasingly important in recent years. The company is well positioned to capitalize on the pullback in lending.
The stock may experience volatility, especially if lending conditions continue tightening. However, its position as a top government lender and role in providing funding for affordable housing makes it an attractive long-term stock to buy a little of today and add to over time as it navigates a tough market.
