Are We Looking at Sunrise or Sunset? 

A recent Wall Street Journal article entitled “Lenders Are Warned on Risk” described concerns, expressed by the Federal Reserve and other financial regulators, regarding potential bubbles in areas of the financial markets. Specifically, the Fed et al noted a potential deterioration in financial controls and underwriting quality for loans used to finance management buyouts, mergers and acquisitions, capital investment, and the like.  

As investors continue to scour the financial markets for higher yielding investments, the financial markets continue to scour their clients for those that need capital and can pay a premium for it. According to S&P Capital IQ LCD, $78 billion of leveraged loans—a record—were sold in February 2013; the prior record was $71 billion in loans issued in February 2007. 

In addition to concerns about the application of underwriting standards and quality during the loan origination process, regulators are concerned about the impact of a financial crisis of any sort on lender’s balance sheets.  Given the recent turmoil the financial markets have undergone, it seems certain the prices of these loans could decline significantly if we face another period when investors want only the most liquid and credit-worthy investments, i.e., sovereign debt and most likely, U.S. government sovereign debt. 

Another concern: what will be the impact on the value of existing loans held by investors such as pension funds, asset managers and the like in their portfolios? If the crisis is worth its salt, interest rates will increase and values of existing debt securities will decline; liquidity will dry up, defaults will increase… not too pretty a picture. 

What can we do to blunt the potential for another sunset in the capital markets? Not much except hope that the regulators guidance has the necessary impact on lender’s behavior. 

Why Is Real Estate Investment So Popular? 

It’s a relative value thing. Just look at the chart which follows which compares private real estate property returns for the fourth quarter 2012and the trailing 12-months ended December 2012 to a wide array of investment alternatives.

Quarter

12 Months Trailing

4Q2012

4Q2012

4Q2011

NCREIF* Property Index

2.5%

10.4%

14.3%

S & P 500

-0.4%

16.0%

2.1%

Barclay’s Capital U.S. Gov’t

0.4%

4.8%

8.7%

NAREIT Equity REIT Index

3.1%

19.7%

8.3%

10-Year U.S. Treasury

1.7%

1.8%

2.8%

12-Month LIBOR

0.9%

1.0%

0.8%

CPI%

0.8%

1.7%

1.7%

*National Council of Real Estate Investment Fiduciaries
**National Association of Real Estate Investment Trusts

And so long as real estate returns provide a premium over alternatives, real estate will remain a favored investment category. 

Monday’s Numbers

The Trepp survey for the most recent period showed spreads decreasing up to 5 basis points. All-in cost for 10-year paper with low loan-to-value ratios remains at sub-four percent levels as the debt market looks to be flourishing. Competition among lenders remains strong as conduits continue to win deals from conventional lenders such as commercial banks and insurance companies.  

Asking Spreads over U.S. Treasury Bonds in Basis Points
(Ten-Year Commercial and Multifamily Mortgage Loans with 50% to 59% Loan-to-Value Ratios)

12/31/09

12/31/10

12/31/11

12/31/12

3/15/13

Month Earlier

Office

342

214

210

210

175

180

Retail

326

207

207

192

166

163

Multifamily

318

188

202

182

157

162

Industrial

333

201

205

191

161

168

Average Spread

330

203

205

194

165

168

10-Year Treasury

3.83%

3.29%

1.88%

1.64%

1.86%

1.97%

The Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads for the period ending March 5, 2013 showed spreads for 10-year, fixed rate mortgages, basically unchanged as compared to the prior survey period ending February 4th.

Liquidity, whether sourced privately from commercial banks and insurance companies, or publicly via the CMBS market, remains abundant and priced aggressively as lenders compete for business. 

10-Year Fixed Rate Commercial Real Estate Mortgages (as of March 5, 2013)

Property

Maximum
 Loan-to-Value

Class A

Class B

Multifamily (Agency)

75% – 80%

T +190

T +195

Multifamily (Non-Agency)

70% – 75%

T +190

T +195

Anchored Retail

70% – 75%

T +210

T +220

Strip Center

65% – 70%

T +230

T +240

Distribution/Warehouse

65% – 70%

T +210

T +220

R & D/Flex/Industrial

65% – 70%

T +225

T +240

Office

65% – 75%

T +195

T +210

Full Service Hotel

55% – 65%

T +260

T +285

Debt service coverage ratio assumed to be greater than 1.35 to 1.

 Year-to-Date Public Equity Capital Markets

DJIA (1): +10.74%
S&P 500 (2): +9.16%
NASDAQ (3): +7.47%
Russell 2000 (4)11.41%
Morgan Stanley U.S. REIT (5):+5.92%

 (1) Dow Jones Industrial Average. (2) Standard & Poor’s 500 Stock Index. (3) NASD Composite Index. (4) Small Capitalization segment of U.S. equity universe. (5) Morgan Stanley REIT Index.

U.S. Treasury Yields

12/31/11

12/31/12

3/23/13

3-Month

0.01%

0.08%

0.07%

6-Month

0.06%

0.12%

0.11%

2 Year

0.24%

0.27%

0.25%

5 Year

0.83%

0.76%

0.79%

7 Year

1.35% 

1.25%

1.29%

10 Year

1.88%

1.86%

1.92%

                                                

Key Rates (in Percentages)

 

Current

1 Yr. Prior

Federal Funds Rate

0.16

0.15

Federal Reserve Target Rate

0.25

0.25

Prime Rate

3.25

3.25

US Unemployment Rate

7.70

8.70

1-Month Libor

0.20

0.24

3-Month Libor

0.28

0.47