Liz Burlingame
The ultra-low interest rate environment induced by the Federal Reserve combined with slowly improving real estate fundamentals will continue to give the real estate capital markets some breathing room in 2013. But that doesn’t mean commercial lenders are feeling worry-free.
Factors external to the lending market continue to pose a threat, including continued global shocks stemming from the recession in Europe and the U.S. budget imbalance. Additionally, a wave of maturing commercial mortgages will grow significantly over the next three years.
Given the market’s mixed signals, commercial lenders are trying to figure out where the chips will ultimately fall. After making strides last year, will the lending market settle into a post-financial-crisis “new normal” in 2013?
Rob Brennan, senior managing director of Guggenheim Partners, a financial services firm based in New York City and Chicago, believes 2012 has paved the way for a brisk start in loan transactions this year. He says Guggenheim completed more deals in the month of December than for all of 2010.
“2012 felt like we were back in terms of an industry,” says Brennan. “Finally, after a long, cold, dark winter in the 2008 to 2010 time frame, we think we’re at a good level of activity.”
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On a year-over-year basis, commercial and multifamily mortgage originations rose 15 percent during the first three quarters of 2012, according to the Mortgage Bankers Association (MBA). Commercial bank portfolios grew their commercial mortgage loan volume by 44 percent during the same period, while loans for Fannie Mae and Freddie Mac grew 39 percent in terms of originations.
Unprecedented low interest rates have served as a tailwind for the lending market, says Jaime Woodwell, vice president of commercial real estate research for MBA. The 10-year Treasury yield was hovering near 1.8 percent in mid-January, and is expected to stay low throughout 2013. “We’ll see interest rates in general remain low but work their way upward,” says Woodwell. “For example, we anticipate that by the end of 2013, they’ll be up half a percentage point from where they are today.”
Rock-bottom rates continue to be a boon for real estate, providing low and attractive financing for borrowers with good credit amid a wave of maturing loans across the industry. According to Newmark Grubb Knight Frank, the volume of maturing loans in need of refinancing hit an all-time record of slightly more than $350 billion last year.
This year, commercial real estate loan rollovers are expected to peak at $375 billion, and from 2013 to 2017, an estimated $1.7 trillion of real estate debt will mature.
To put this in perspective, property sales volume in the peak year of 2007 totaled $570 billion, Newmark Grubb Knight Frank reports. CMBS rollovers will rise 119 percent over the next five years, peaking in 2017 at $136 billion. This reflects the surge in 10-year CMBS deals leading up to the recession.
“There is some queasiness in the market about the volume of loan rollovers in the next few years,” according to a recent Newmark Grubb Knight Frank report. “But the decline in the level of distressed assets, falling delinquency rates for bank and CMBS loans and the ongoing recovery in the leasing markets suggest that the industry will work through this process in an orderly fashion.”
Rates Revive Values
Along with boosting refinancing activity, today’s low rates have helped reflate the value of certain assets, due to the availability of capital, says Brennan. However, the low rates have also heightened competition among lenders. “In some ways, it’s starting to feel like the more euphoric time pre-crash, when folks started to get very aggressive on underwriting and on leverage. We’re not all the way there yet, but we feel like we’re moving in that direction.”
“Certain markets and property types have probably lagged, but in general there’s been more capital available for virtually any product in any location,” he adds. “That is a function of the Fed keeping rates artificially low for a long period of time. Investors search for yield. Whether it’s the corporate bond market, the emerging markets or the property markets, it’s the same phenomenon.”
Many financial experts warn that a prolonged period of low interest rates could fuel the next asset bubble that, while not imminent, could have major consequences. “The Fed is going to have to do an extraordinary job of withdrawing the liquidity at some point and many folks fear the Fed won’t be able to do that gracefully,” says Brennan. He adds that the Fed’s effort to withdraw themselves from this position could lead to inflation down the road.
As it has in past years, Guggenheim plans to focus on financing stable assets in primary markets. The company, run by CEO Mark Walker, has united a range of businesses under the Guggenheim brand in the past 13 years — from asset management to aircraft leasing. Recently, Guggenheim affiliate Pillar Financial added FHA products to its portfolio, after Pillar acquired St. James Capital, an FHA lender and approved Ginnie Mae multifamily issuer specializing in construction and permanent multifamily debt financing.
Brennan expects the company to stay active in the Southeast this year and points to healthy fundamentals in Florida. “There’s been a strong recovery in the Florida markets, especially on the residential side.”
In Miami, after suffering from overdevelopment and cheap credit in 2007, the popular condominium market collapsed, according to the 2013 Emerging Trends report produced jointly between PricewaterhouseCoopers and The Urban Land Institute. But five years later demand is back again — from both domestic capital and foreign investors who are swooping in to take advantage of the demand.
Other active Southeast markets will likely include Atlanta, Raleigh/Durham and Charlotte, says Matthew Rocco, executive vice president and national production manager with Grandbridge Real Estate Capital, a commercial and multifamily mortgage banking firm.
As competition for quality assets heats up in the highly favored gateways, money will continue to slowly wend its way into the stronger secondary markets.
As Brennan explains, “The easy money gets made first in the safe, no-brainer locations like office properties in Midtown New York and retail owned and operated by the likes of [Simon Property Group] or GGP. Eventually the competition brings lending rates or cap rates down in the favored gateway cities and you move on in search of yield. Two years ago, lenders wouldn’t go anywhere outside the major metropolitan markets. Today, there’s all sorts of talk about going into secondary and tertiary markets. Because cap rates are so low in Manhattan, you can’t justify [the deal]. I’d rather take more risk and go to a secondary market, put my money to work and get more return.”
Apartments Press Forward
Rocco estimates that Grandbridge’s lending activity consisted of 60 percent refinancing loans and 40 percent acquisition loans in 2012. Like last year, a large portion of the business will remain tied to the apartment sector in 2013. “Multifamily by and far remains the most attractive asset class, supported by low borrowing rates by Fannie Mae and Freddie Mac as well as banks and CMBS lenders,” says Rocco.
Additionally, the combination of strong renter demand and limited new supply has led to intense investor interest in the apartment sector. In some gateway cities, cap rates have fallen below five percent.
During the first three quarters of 2012, originations for multifamily properties rose 30 percent from the same period in 2011, according to the MBA. Healthcare posted the strongest improvement of the property sectors, with a 33 percent increase in originations.
“If you look at employment numbers, healthcare throughout the recession and to the present, has been one of the areas with consistent growth,” says Woodwell.
Last year, the healthcare sector added 338,000 net new payroll jobs. Since the Labor Department began tracking the healthcare sector in 1990, there has only been one month of job losses (in July 2003).
The CMBS market, which is helping to fill a void in secondary and tertiary markets, will continue to see steady improvement this year, predicts Michael Higgins, managing director and head of real estate finance at the Canadian Imperial Bank of Commerce World Markets (CIBC).
“Between balance sheet and CMBS, we closed about $5 billion in loans last year,” says Higgins, adding that CIBC expects to close between $6 billion and $8 billion in 2013.
CMBS has played a major role in tertiary property markets, accounting for 24 percent of the total debt issued in these areas from mid-2011 to mid-2012, compared with 12 percent in secondary markets and 11 percent in primary markets.
Growing investor demand for CMBS, coupled with the expected continued government bond buying, is fueling optimism that issuance could increase to between $50 billion and $75 billion this year, up from $40 billion in 2012.
In terms of lender appetite, CMBS market sentiment is improving, points out Newmark Grubb Knight Frank, but spreads are a slave to macro events, and there was some softening recently due to the drama surrounding the fiscal cliff. Although that crisis has passed, spreads could widen again if macro events turn choppy.
Based on early indicators, Brennan expects the lending pipeline will be robust this year, adding there’s still risk from large imbalances in the global economy. “In the last five years, the list of potential things that could create that exogenous shock to send us back over the edge has grown quite long,” says Brennan. “We’re chipping away at it, and every year past 2009 it gets a little less [worrisome], but there are still a lot of boogeymen in the closet.”