The year 2013 will be characterized as one in which both equity and debt capital were plentiful and inexpensive by historical standards. In fact, throughout the year, the abundance of capital was frequently referred to as the “wall of capital,” intimating flows of funds so large as to inundate the markets.
Last week, we reviewed capital flows in the real estate capital markets in 2013; this week, we climb out on a limb and start sawing as we try to forecast what 2014 will look like.
Let’s start with the public real estate capital markets—real estate investment trusts (REITs).
REITs raised about $75 billion in 2013 from a wide array of sources, including initial and secondary offerings of common shares, preferred shares, and unsecured (primarily rated) debt offerings. For REITs, 2014 looks like more of the same: overall valuations are attractive; real estate fundamentals continue to strengthen company balance sheets and operating metrics; and management teams remain focused and disciplined in executing operating strategies. REIT dividends remain an extremely attractive investment alternative—though an unlikely increase in interest rates could derail our prognosis. Otherwise, REITs should have access to adequate supplies of capital in 2014.
Commercial Mortgage–Backed Securities
A banner year is predicted for originations of securitized commercial mortgages, with domestic (U.S.) volume in the $100 billion range, up from $86 billion in 2014. Institutional investors continue to support securitization of commercial mortgages for reasons ranging from yield compared with alternatives, to investment diversification. Industrywide acquisition and sale transaction volumes will clearly be sufficient to support $100 billion in issuance.
Commercial mortgage–backed securities (CMBS) is becoming an increasing market threat to other lenders such as commercial banks and insurance companies as securitized lenders expand their market presence in gateway markets and core properties; size does not appear to be an issue at present.
What to watch for: weakening in the underwriting culture—interest-only periods longer than two years, loan-to-value ratios in excess of 80 percent, debt coverage ratios of 1 to 1, pro-forma underwriting, and the like. That said, the industry seems intent on “not getting too far out over its skis” this time.
Acquisitions and Dispositions of Income-Producing Commercial Property
The investment market seems adequately capitalized, with numerous parties focused on real estate investment. All the usual sources and suspects are expected to be active in 2014, including offshore investors seeking safety and yield, pension investors looking for investments to fund distributions to beneficiaries, global private investment funds looking for leveraged investments, and public and nonpublic REITs.
Transaction volume is projected at $325 billion to $350 billion.
Spreads for Conventional Mortgage Loans
With the Federal Reserve Board’s recent guidance regarding interest rates in 2014 in hand, it seems likely that spreads for commercial real estate mortgage loans will remain relatively unchanged in 2014, ranging from 150 to 200 basis points. When combined with the anticipated yield on ten-year Treasury bonds (3.00 percent), all-in costs in the 4.0 to 5.0 percent are expected.
Subject to the usual uncertainties, fluctuations in the markets, and other unpredictable events, 2014 will be a vintage year.
Commercial Banks
Finished with deleveraging and profitable quarter-over-quarter, commercial banks are finally in a financial position that will allow them to increase the size of their loan book. Banks will increase their participation in the debt capital markets through an array of strategies that include acting as principal in providing on-balance-sheet financing and acting as agent in securitized transactions. Construction financing will be available on a selective basis.
Lending volume in the range of $150 billion is our projection for 2014.
Insurance Companies
Year in, year out, insurance companies provide about $50 billion of commercial mortgage financing; 2014 will be no exception.
In summary, participants in the commercial real estate industry appear to have access to an adequate supply of equity and debt capital.
Monday’s Numbers
The Trepp survey for the period ended January 10 showed spreads coming in an average of 11 basis points compared with the previous survey period.
Asking Spreads over U.S. Ten-Year Treasury Bonds in Basis Points | ||||||||
12/31/09 | 12/31/10 | 12/31/11 | 12/31/12 | 12/31/13 | 1/3/14 | 1/10/14 | ||
| Office | 342 | 214 | 210 | 210 | 162 | 165 | 156 | |
| Retail | 326 | 207 | 207 | 192 | 160 | 165 | 153 | |
| Multifamily | 318 | 188 | 202 | 182 | 157 | 159 | 148 | |
| Industrial | 333 | 201 | 205 | 191 | 159 | 161 | 150 | |
| Average spread | 330 | 203 | 205 | 194 | 160 | 163 | 152 | |
| 10-year Treasury | 3.83% | 3.29% | .88% | 1.64% | 3.04% | 3.01% | 2.88% | |
The most recent Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly survey of commercial real estate mortgage spreads, dated January 8, 2014, showed spreads coming in +/–5 basis points during the survey period.
Ten-Year Fixed-Rate Commercial Real Estate Mortgages (as of January 8, 2014) | |||
Property | Maximum | Class A | Class B |
| Multifamily (agency) | 75%–80% | T +195 | T +200 |
| Multifamily (nonagency) | 70%–75% | T +195 | T +205 |
| Anchored retail | 70%–75% | T +205 | T +210 |
| Strip center | 65%–70% | T +220 | T +230 |
| Distribution/warehouse | 65%–70% | T +195 | T +210 |
| R&D/flex/industrial | 65%–70% | T +210 | T +225 |
| Office | 65%–75% | T +195 | T +210 |
| 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: –0.71%
Standard & Poor’s 500 Stock Index: –0.52%
NASD Composite Index (NASDAQ): +5.00%
Russell 2000: +0.041%
Morgan Stanley U.S. REIT Index: –0.032%
U.S. Treasury Yields | |||
12/31/12 | 12/31/13 | 1/17/14 | |
| 3-month | 0.08% | 0.07% | 0.05% |
| 6-month | 0.12% | 0.10% | 0.07% |
| 2-year | 0.27% | 0.38% | 0.40% |
| 5-year | 0.76% | 1.75% | 1.64% |
| 7-year | 1.25% | 2.45% | 2.27% |
| 10-year | 1.86% | 3.04% | 2.84% |
