In January 2008, Real Estate Research Corporation reported the results of its fourth-quarter 2007 institutional investor survey of metrics underlying acquisition transactions. These include going-in capitalization rates, assumed terminal capitalization rates, and required rates of return calculated on an internal rate of return (IRR) basis.

While few investors recognized it at the time, real estate investment had reached an inflection point, with each of the measures reaching its high-water mark for the cycle:

  • going-in cap rates: 6.60 percent;
  • terminal cap rates: 7.30 percent; and
  • internal rate of return: 8.20 percent.

The metrics show that investors were starting to “bet the ranch” as they continued to pursue property acquisitions in the face of an all-but-declared recession, the demise of Bear Stearns, the merger of Bank of America and Merrill Lynch, and the AIG bailout by the Federal Reserve, etc.

By the fourth quarter of 2009, the dive to the bottom had been replaced by the most conservative acquisition metrics of the decade, as follows:

  • going-in cap rates: 8.60 percent;
  • terminal cap rates: 8.90 percent; and
  • internal rate of return: 10.10 percent.

But nothing lasts forever, and we find ourselves once again faced by a “wall of capital” intent on buying all types of real estate in all types of locations at increasingly higher prices based on the use of increasingly aggressive metrics. This is shown by the most recent (fourth quarter 2013) Real Estate Research Corporation survey, which shows:

  • going-in cap rates: 6.70 percent;
  • terminal cap rates: 7.30 percent; and
  • internal rates of return: 8.40 percent.

All are at their lowest levels since the fourth quarter 2007.

Will the results of the Real Estate Research Corporation survey (and similar surveys) provide the necessary “shake-up call,” defined by one futurist as the difference between heartburn and a heart attack, or will we once again suffer the consequences?

Monday’s Numbers

The Trepp survey for the period ended February 21 showed spreads continuing to decrease, averaging 144 basis points over ten-year U.S. Treasuries. We do not know how long this will continue, but urge people looking for mortgage loans to go long, fast; these rates can only last for so long.

Asking Spreads over U.S. Ten-Year Treasury Bonds in Basis Points
(Ten-year commercial and multifamily mortgage loans
for properties with 50% to 59% loan-to-value ratios)

12/31/09

12/31/10

12/31/11

12/31/12

12/31/13

2/21/14

Month earlier

 Office

342

214

210

210

162

148

155

 Retail

326

207

207

192

160

146

151

 Multifamily

318

188

202

182

157

139

146

 Industrial

333

201

205

191

159

143

150

 Average spread

330

203

205

194

160

144

151

 10-year Treasury

3.83%

3.29%

0.88%

1.64%

3.04%

2.73%

2.88%

 

The most recent Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads, dated February 11, shows spreads unchanged (anchored and strip centers, industrial sectors, and office) to 5 basis points wider (everything else).

 

 Ten-Year Fixed-Rate Commercial Real Estate Mortgages
(as of February 11, 2014)

Property

Maximum
loan-to-value

Class A

Class B

 Multifamily (agency)

75–80%

T +180

T +185

 Multifamily (nonagency)

70–75%

T +185

T +195

 Anchored retail

70–75%

T +205

T +220

 Strip center

65–70%

T +220

T +235

 Distribution/warehouse

65–70%

T +195

T +210

 R&D/flex/industrial

65–70%

T +210

T +230

 Office

65–75%

T +195

T +215

 Full-service hotel

55–65%

T +255

T +280

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

 

Year-to-Date Public Equity Capital Markets

Dow Jones Industrial Average: –1.54%

Standard & Poor’s 500 Stock Index: –0.60%

NASD Composite Index (NASDAQ): +3.15%

Russell 2000: +1.67%

Morgan Stanley U.S. REIT Index: +6.24%

 

Year-to-Date Global CMBS Issuance
(in $ billions as of 2/28/14)

2014

2013

U.S.

$10.3

$17.9

Non-U.S.

0.0

1.0

Total

$10.3

$18.9

Source: Commercial Mortgage Alert

 

U.S. Treasury Yields

12/31/12

12/31/13

2/28/14

 3-month

0.08%

0.07%

0.05%

 6-month

0.12%

0.10%

0.08%

 2-year

0.27%

0.38%

0.32%

 5-year

0.76%

1.75%

1.51%

 7-year

1.25%

2.45%

2.18%

 10-year

1.86%

3.04%

2.65%