Monday’s Numbers: September 30, 2013

As predicted here in the past, the recent run-up in rates is starting to affect deals.

In the July 1, 2013 issue of Monday’s Numbers, we examined the potential impact that the recent run-up in interest rates could have on the pricing and volume of real estate transactions. We approached the problem and the dilemma facing each of the four quadrants of the real estate capital markets—buyers, sellers, borrowers, and lenders—through a series of “what if” exercises.

In the July 22, 2013, issue, we examined the potential impact that the then-recent 30-basis-point widening in average spreads combined with a 75-basis-point increase in the yield on ten-year Treasury bonds could have on commercial real estate transactions. Our conclusion: leveraged buyers were going to rethink the prices they were willing to pay for property.

Last week, these kinds of scenarios became reality. In a transaction involving an income-producing property, the highest bidder terminated its contract near the end of the due diligence period. While there may have been due diligence issues that needed to be addressed, our sources believe the transaction “fell apart” when the buyer found itself unable to secure some portion of the required equity and/or debt or both due to increases in interest rates. When contacted, other potential purchasers who had made it to the final round reduced their previous highest and best final offers by increasing their acquisition capitalization by 50 to 60 basis points due to increases in interest rates.

Monday’s Numbers

The Trepp survey for the period ending September 20, 2013, showed spreads unchanged during the survey period as the markets hold their collective breaths and wait to see if the U.S. government opens for business next week.

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.

Year-to-Date Public Equity Capital Markets

DJIA ⁽¹⁾: +16.44%
S&P 500 ⁽²⁾:+18.62%
NASDAQ ⁽³⁾: +25.24%
Russell 2000 ⁽⁴⁾:+26.47%
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.}