A Q&A on the debt ceiling appeared in last week’s New York Times, providing a perspective on both what’s going on in Washington from the debt ceiling point of view and the economic consequences of a lack of solution.

If the debt ceiling is not increased and the United States defaults (technically or actually) on its obligations, the consequences are thought by most experts to be dire, including substantial declines in the stock market, large increases in short- and long-term interest rates, and an economy rapidly entering into a deep and serious recession.

In an informal survey conducted during the past week, we noted very little, if any, change in acquisition and/or financial metrics of transactions involving properties located in 24-hour gateway markets. On the other hand, a number of transactions involving properties located in secondary and other markets were reported to have undergone some retrading as to sale price due to an increase in capitalization or loan proceeds attributable to changes in required debt-coverage ratios, or required debt yields, or loan-to-value ratios.

Improved Fundamentals

What better evidence that commercial real estate fundamentals are improving than the fact that delinquency rates for commercial mortgage–backed securities (CMBS) continue to decline. According to Trepp LLC, the delinquency rate for commercial real estate loans in previously securitized transactions declined for the fourth consecutive month, falling to 8.14 percent, a decline (i.e., improvement) of 185 basis points since one year ago. This month’s level is the lowest delinquency rate reported by Trepp since July 2010.

As the following chart indicates, retail properties continue to be the best-performing sector, with industrial properties remaining the worst. Office assets showed the best month-over-month improvement with a 29-basis-point decrease while hospitality showed the greatest increase (12 basis points).

 

 

September 2013

Three months ago

Six months ago

One year ago

Industrial

11.59%

11.72%

11.72%

12.21%

Hospitality

9.15%

9.43%

11.82%

12.16%

Industrial

11.13%

11.69%

12.73%

14.09%

Office

9.31%

9.97%

10.60%

10.48%

Retail

6.50%

7.08%

7.91%

8.09%

Overall

8.14%

9.65%

9.50%

9.99%

Another Positive

The Architecture Billing Index, a leading economic indicator of future construction activity, scored 53.8 in August, up from 52.7 in July.

Monday’s Numbers

The Trepp survey for the period ending September 27, 2013, showed spreads basically unchanged during the survey period as the markets tread water waiting to see what happens with the debt ceiling. One should expect the debt markets to be in a holding pattern until the debt ceiling is resolved.

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

9/6/13

9/13/13

9/20/13

9/27/13

Office

342

214

210

210

175

178

176

174

Retail

326

207

207

192

161

168

163

163

Multifamily

318

188

202

182

156

160

159

158

Industrial

333

201

205

191

161

163

163

161

Average spread

330

203

205

194

163

163

164

164

10-Year Treasury

3.83%

3.29%

1.88%

1.64%

2.88%

2.88%

2.75%

2.64%

 

The most recent Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads dated September 9, 2013, showed spreads coming in 5 basis points during the survey period.

We expect the rest of the year to play out as follows: with interest rates expected to increase in the near future, borrowers will focus on closing committed deals as soon as possible so as to lock in today’s cheap financing. On the other hand, you will see lenders trying to dig in their heels and not get locked in to subpar returns for up to a ten-year holding. All-in costs should range in the 4.50 to 5.00 percent area.

Ten-Year Fixed-Rate Commercial Real Estate Mortgages
(as of September 13, 2013)

Property

Maximum
 loan-to-value

Class A

Class B

Multifamily (agency)

75–80%

T +205

T +215

Multifamily (nonagency)

70–75%

T +215

T +220

Anchored retail

70–75%

T +220

T +235

Strip center

65–70%

T +240

T +255

Distribution/warehouse

65–70%

T +220

 T +235

R & D/flex/industrial

65–70%

T +235

T +255

Office

65–75%

T +210

T +230

Full-service hotel

55–65%

T +270

T +295

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

 

Year-to-Date Public Equity Capital Markets 

DJIA (1): +15.02%
S & P 500 (2): +16.11%
NASDAQ (3): +26.11%
Russell 2000 (4)+26.95%
Morgan Stanley U.S. REIT (5): +1.46%

(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

10/04/13

3-Month

0.01%

0.08%

0.03%

6-Month

0.06%

0.12%

0.04%

2-Year

0.24%

0.27%

0.33%

5-Year

0.83%

0.76%

1.41%

7-Year

1.35%

1.25%

2.05%

10-Year

1.88%

1.86%

2.66%

                                     

Key Rates (in Percentages)

 

Current

One year prior

Federal funds rate

0.09

0.17

Federal Reserve target rate

0.25

0.25

Prime rate

3.25

3.25

U.S. unemployment rate

7.30

8.50

1-Month LIBOR

0.17

0.22

3-Month LIBOR

0.24

0.35