A recent article in Bloomberg Businessweek described how yield-starved investors, seeking to augment their income, were turning their attention and pent-up buying power to riskier and riskier investments. And companies, seeing the opportunity to borrow at ever-lower costs, are taking full advantage, issuing more than $350 billion of bonds year-to-date, on pace to exceed last year’s record $447 billion of issuance.

So far, so good; investors in junk bonds have achieved a total return of 157 percent since the height of the financial crisis in 2008. But as the director of fixed income and equity research at a private bank noted: “You can stay in overexuberant conditions for a while . . . but when it turns, it will turn quickly and it will turn very ugly.”

At present, the power rests with borrowers, who are taking advantage of their position to dictate terms and conditions, resulting in the lowest level of covenant protection since 2011 and average junk bond yields equal to a record 5.6 percent level.

Two examples will suffice in explaining why we think it is wise to be concerned: First, China’s Logan Property Holdings, which has negative cash flow, sold $300 million in bonds in May 2014. And second, Clear Channel Communications, whose credit rating indicates that default is almost a certainty, more than doubled a May 2014 bond offering to $850 million.

Are There Bubbles Out There?

The answer is: we don’t know. It may feel like we are at, or coming close to, some type of inflection point when we look at the prices being paid for properties—top tier or not—located on dry land. The distinctions used to define investments and investment strategies have changed markedly in the past 18 months to accommodate the huge influx in capital wanting to be invested in real estate.

For sure, there are plenty of investors ranging from institutional behemoths to local sharpshooters who have dirty fingernails and pointed elbows and who believe they can both take care of themselves as well as find properties where there is still “meat left on the bones.”

We believe that to be true. We also see evidence that it’s pretty frothy out there, and one does not have to go too far to see examples of bubble-like behavior (or bubbles-in-training) in the capital markets.

A recent article in the Financial Times noted five euro-centric instances where it believed low interest rates have aided and abetted investors in an ever-riskier “hunt for yield,” including:

  1. Leveraged loans backed by weak covenants; see the Bloomberg story referenced above.
  2. Exchange-traded funds (ETFs): With trading volume up a reported 18 percent year-over-year, a decline in the one of the sectors of the securities market underlying the ETF could ripple through the market; if two or more sectors are affected simultaneously, watch out. The regulators seem particularly watchful as it relates to leveraged-loan ETFs.
  3. Eurozone sovereign debt: Are the euro-based economies that much stronger than they were a year ago that yields on some euro sovereign debt are as low as 3 percent for debt having a ten-year term?
  4. Eurozone bank paper: Would you be concerned if you read a story highlighting banks issuing contingent convertible bonds known as “cocos”? The article refers to them as “rinky-dink instruments” that convert from debt to equity if the issuer’s capital levels decline.
  5. U.K. property: When the prime minister, facing impending elections, acknowledges that U.K. property may be the most bubbly asset class of all, you’ve got issues.

This week’s comments should be read for what they are—an expression of concern and a warning to be watchful and careful.

Monday’s Numbers

The Trepp survey for the week ending July 11 showed spreads declining 2 to 4 basis points unchanged as the financial markets tried to cope with continuing twin geopolitical upheavals. The implied rate for ten-year, modestly leveraged commercial real estate mortgages remains slightly below 4 percent. The market seems to be holding its collective breath, waiting to react to the unfolding geopolitical storms.

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)

12/31/10 12/31/11 12/31/12 12/31/13 This week(7/18/14) Last week(7/11/14) Month earlier
 Office 214 210 210 162 140 144 148
 Retail 207 207 192 160 133 137 138
 Multifamily 188 202 182 157 130 132 135
 Industrial 201 205 191 159 132 135 136
 Averagespread 203 205 194 160 134 137 139
 10-yearTreasury 3.29% 2.88% 1.64% 3.04% 2.50% 2.53% 2.61%


The Cushman & Wakefield (C&W) Equity, Debt, and Structured Finance Group’s monthly Capital Markets Update of commercial real estate mortgage spreads, dated July 10, 2014, showed spreads coming in approximately 5 basis points since the prior survey (dated June 5) as lenders continue to compete for business; implied all-in cost ranges from 4.25 percent to 4.50 percent.

In its “Market Commentary,” C&W noted that issuance of commercial mortgage–backed securities (CMBS) had declined 8 percent during the first half of 2014 but was expected to increase during the second half of the year, as there is almost $20 billion worth of deals in the pipeline.

Ten-Year Fixed-Rate Commercial Real Estate Mortgages (as of July 10, 2014)



Class A

Class B

 Multifamily (agency) 75–80% T +170 T +170
 Multifamily (nonagency) 70–75% T +165 T +180
 Anchored retail 70–75% T +185 T +195
 Strip center 65–70% T +190 T +200
 Distribution/warehouse 65–70% T +180 T +200
 R&D/flex/industrial 65–70% T +190 T +210
 Office 65–75% T +185 T +195
 Full-service hotel 55–65% T +240 T +260
 Debt-service-coverage ratio assumed to be greater than 1.35 to 1.


Year-to-Date Public Equity Capital Markets

Dow Jones Industrial Average: +2.32 percent

Standard & Poor’s 500 Stock Index: +6.81 percent

NASD Composite Index (NASDAQ): +6.54 percent

Russell 2000: –1.63 percent

Morgan Stanley U.S. REIT Index: +14.21 percent


Year-to-Date Global CMBS Issuance
(in $ billions as of 7/25/14)

2014 2013
U.S. $47.7 $49.3
Non-U.S. 1.9 7.8
Total $49.6 $57.1
Source: Commercial Mortgage Alert


Year-to-Date Public U.S. Treasury Yields

U.S. Treasury Yields

12/31/12 12/31/13 7/25/14
 3-month 0.08% 0.07% 0.03%
 6-month 0.12% 0.10% 0.06%
 2-year 0.27% 0.38% 0.53%
 5-year 0.76% 1.75% 1.69%
 7-year 1.25% 2.45% 2.14%
 10-year 1.86% 3.04% 2.28%