The 20th Annual ULI/McCoy Symposium on Real Estate Finance was held last week in New York City. The invitation-only event provides an opportunity for industry leaders in the arena of real estate finance and capital markets to discuss issues of common concern to participants in the real estate industry. Industry stakeholders represented at the meeting included the following: representatives of commercial banks, securitized lenders (commercial mortgage–backed securities [CMBS]), insurance companies, mezzanine lenders, debt funds, public companies (real estate investment trusts [REITs]), private equity funds, real estate development, and real estate economists.

The symposium is held under the Chatham House Rule, which allows participants to use any information received at the symposium, but requires that the identity and affiliation of the speaker(s), or that of any other participant(s), may not be revealed.

The first session included a presentation and moderated discussion of the economy. The key takeaways from the session were not the discussion and analysis of the numbers (gross domestic product [GDP], budget deficits, projected interest rates, etc.), but rather the concern expressed by many regarding government’s ability to deal with the next phase of the economic Rubik’s Cube, including “tapering.”

Participants expressed concern about “competence,” noting that while the Federal Reserve and the administration are trying to do the right thing, no one’s experience has trained them to deal with these types of issues as we enter a period of uncertainty where we do not know what the rules are.

In regard to interest rates, we all know they are going up, most probably within the next 12 months; however, the question raised at the symposium was not where interest rates are going and when, but rather that managing the process will take the Federal Reserve into “wildly” unknown territory.

It was noted that the incoming chair, Janet Yellen, could both keep rates lower for longer as well as decrease the Fed’s unemployment trigger point to, say, 5.5 percent.

The majority of participants agreed that the Federal Reserve’s next step should be to start the normalization process as soon as possible rather than wait for an extraneous event.

The second session included a presentation and moderated discussion of the state of the single-family housing market, noting that “housing led us both into and out of the current recession,” with the bottoming phase of the current cycle beginning in January 2012.

The third and fourth sessions included a presentation on the state of the real estate capital markets and moderated discussions regarding the equity and debt capital markets. The key takeaway from both the individual equity and debt sessions was not who was in or out of the markets (the same suspects as usual– “all-in”) or what deals can or cannot get done (there seems to be no deal that cannot get done), it’s that there is “wall of capital” supporting the real estate investment and lending space. To date, capital has acted very responsibly and leverage has not gotten out of hand. In fact, the wall of equity in search of income-producing investments is a global issue.

In regard to the equity capital markets, participants noted that offshore investors continue to regard the United States as a safe haven, providing both safety as well as higher returns on investment than their home markets, while pension funds view real estate’s cash flow from operations as critical to their ability to make required distribution to beneficiaries. Private real estate funds continue to probe the globe in search of high-yield investment opportunities, while REITs stick to time-honored investments and operating strategies. As investors conclude that financial engineering has been replaced by property engineering, more and more investors turn to value-added strategies.

In the commercial real estate debt markets, banks have completed the majority—if not all—of their deleveraging and have become increasingly profitable, allowing them to expand their loan books, including originating loans for eventual securitization. Construction financing is increasingly available, principally for multifamily and preleased office properties.Participants noted that borrowers should be working to protect themselves against inevitable interest rate increases by extending maturities whenever the opportunity arises.

Insurance companies, sensing an increasingly competitive lending environment, are widening their focus to include noninstitutional properties in secondary locations. In fact, all lenders are “widening their nets” in search of deals, causing the market to become increasingly competitive. Loan-to-value ratios of 65 percent are becoming the accepted norm for the insurance industry.

The CMBS sector continues its recovery, with issuance projected to reach $85 billion in 2013 and $100 billion (probably more) in 2014. Both delinquencies as well as material defaults continue to decline. Issuers continue to focus on assets located in secondary and tertiary markets. A yellow caution flag, however, was raised over the increasing number of interest-only loans coming to market.

The mezzanine space is becoming increasingly crowded as investors search for higher-yielding investments.

Overall, the real estate industry appears to be dealing very credibly with a wide array of incredible uncertainties; it is hoped that this all’s–right-with-the-world phase will continue.

Monday’s Numbers

The Trepp survey for the period ending December 6, 2013, showed very little change over the prior period as the industry is focusing all of its attention on getting deals “papered and closed” before year-end.

Asking Spreads over U.S. 10-Year Treasury Bonds in Basis Points
(10-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

11/1/13

11/1/13

11/18/13

12/6/13

Office

342

214

210

210

181

181

177

173

Retail

326

207

207

192

174

174

175

171

Multifamily

318

188

202

182

159

159

166

163

Industrial

333

201

205

191

162

162

169

166

Average spread

330

203

205

194

169

169

172

168

10-Year Treasury

3.83%

3.29%

.88%

1.64%

2.65%

2.65%

2.71%

2.70%

 

The most recent Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads dated November 4, 2013, showed spreads coming in 15 basis points during the survey period.

Applying an average spread of 200 basis points, borrowers are looking at all-in costs of about 4.75 to 5.00 percent for fixed-rate mortgages with a 70 to 75 percent loan-to-value ratio. These spreads must be attractive to both borrowers as well as lenders as the Mortgage Bankers Association recently reported that third-quarter commercial/multifamily origination volume was up 29 percent, year over year. The increase in origination volume was led by CMBS, whose volume increased 105 percent year over year, followed by life insurance companies with a 72 percent increase year over year. 

10-Year Fixed-Rate Commercial Real Estate Mortgages (as of November 4, 2013)

Property

Maximum
loan-to-value

Class A

Class B

Multifamily (agency)

75–80%

T +195

T +200

Multifamily (nonagency)

70–75%

T +200

T +210

Anchored retail

70–75%

T +205

T +220

Strip center

65–70%

T +225

T +240

Distribution/warehouse

65–70%

T +200

 T +215

R&D/flex/industrial

65–70%

T +215

T +235

Office

65–75%

T +195

T +215

Full-service hotel

55–65%

T +250

T +275

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

 

Year-to-Date Public Equity Capital Markets

Dow Jones Industrial Average: +20.23%
Standard & Poor’s 500 Stock Index:+24.48%
NASDAQ (1): +32.50%
Russell 2000 (2): +30.34%
Morgan Stanley U.S. REIT Index: -0.095%

(1) NASD Composite Index; (2) Small-capitalization segment of U.S. equity universe.

U.S. Treasury Yields

12/31/11

12/31/12

12/15/13

3-Month

0.01%

0.08%

0.07%

6-Month

0.06%

0.12%

0.09%

2-Year

0.24%

0.27%

0.34%

5-Year

0.83%

0.76%

1.55%

7-Year

1.35%

1.25%

2.21%

10-Year

1.88%

1.86%

2.89%

Key Rates (in Percentages)

Current

One year prior

Federal funds rate

0.10

0.17

Federal Reserve target rate

0.25

0.25

Prime rate

3.25

3.25

U.S. unemployment ate

7.00

8.50

1-Month LIBOR

0.17

0.21

3-Month LIBOR

0.24

0.31