Regardless of your investment or operating quadrant—public or private real estate equity or debt—or property sector (multifamily, office, industrial, retail, or hospitality), 4Q 2010 turned out to be pretty okay.
Fundamentals started to steady themselves and while vacancy rates remain high and rents remain stagnant (and many other indicators remain elevated), we appear to have finally reached an inflection point with most analysts (and evidence) agreeing that the worst is behind us. It is not going to get better quickly, but it is going to get better.
Real Estate Investment Trusts
The Morgan Stanley REIT Index was up 3.13% in the fourth quarter, and ended the year up slightly more than 23.0%, ahead of all the major indices including the Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index, the NASDAQ Composite Index, and the Russell 2000.
That makes two years in a row that REIT shares have outperformed the field; the question is, can they 3-peat? Certainly REITs, with their access to the public equity and debt capital markets, are poised and well positioned to take advantage of opportunities. We’ll see.
Commercial Mortgage-Backed Securities (CMBS)
Securitization 2.0 is alive and well as evidenced by the fact that nine offerings totalling approximately $7.1 billion were completed during the fourth quarter. Deals priced included both single as well as multi-borrower transactions from a wide array of underwriters including: J.P. Morgan; Deutsche Bank; Ladder Financial; Natixis; Wells Fargo; Bank of America; Barclays Capital; Goldman Sachs; and Citigroup. Equally as encouraging, additional firms are entering the market, thereby adding both competition and capacity.
While still facing record high delinquencies and a tsunami of maturing loans requiring refinancing, CMBS has risen like a biblical prophet; hopefully, it will retain its memory of its prior excesses and continue to enforce stringent underwriting standards.
Private Real Estate Equity Capital Markets
Rates of return—up; transaction volume—up; capitalization rates—down; what more is there to say.
The National Council of Real Estate Investment Fiduciaries’ (NCREIF) National Property Index, which is comprised of over 6,000 properties valued at in excess of $238 billion, turned positive in the third quarter of 2010, a trend which is expected to continue as both the national and real estate economies continue to recover. The NCREIF index had shown sequentially negative results on a trailing 12-month basis beginning with December 31, 2008. Allocations to real estate by institutional investors should continue (and possibly accelerate) as real estate yields remain highly competitive with other investment alternatives.
In terms of transaction volume, anecdotal evidence points to sales in the $20 to $25 billion range in the fourth quarter and full year sales in the $100 billion range. That is quite respectable overall and a good base for 2011 to build on. There remains a wall of capital that wants to invest in real estate.
According to Real Estate Research Corporation’s most recent survey, capitalization rates continued to tighten, ending the quarter at 7.57% (average) versus 7.97% at the end of the third quarter. The capitalization rate spread over 10-year Treasury bonds, as of December 31, 2010, was a robust 4.25%, which seems to weight risk appropriately and therefore continue to make real estate an attractive investment.
Private Debt Real Estate Capital Markets
Insurance companies continue to gain market share as they focus on higher quality assets and stronger borrowers. Banks remain cautious, preferring to continue to strengthen their balance sheets and income statements in preparation for the long anticipated wave of restructurings and/or foreclosures. Spreads are reported in the 200 to 225 basis point range over 10-year Treasury Bonds, which is clearly attractive as it provides positive leverage except for those transactions involving the “most trophy of trophies” (where capitalization rates in the low 5’s have been reported).
Lenders will continue to remain cautious and selective. That said, mortgage capital will remain available for “bankable borrowers.”