Real Estate News & Commentary by Jeff Adams
With the prices of conventional real estate at or near cyclical highs, there is a growing interest by investors in commercial real estate investing, which have many of the financial advantages, including predictable cash flow.
These days, money is doing a delicate dance where commercial real estate is concerned. The slowing economy has pinched many an investor, and with it, many new development plans have been scotched.
But surprisingly, real estate is weathering the storm nicely. Unlike the early-1990s depression, supply and demand have remained fairly well in check across most property types; and the free-flowing capital supply that was so prevalent then isn’t around now to exacerbate the slowdown.
Another telling sign of the times: REITs are back. The predominant perception last year was that REITs were dead, but what a difference a few quarters can make. REITs are now issuing millions in new debt for the first time in years, and their merging mentality will create new monied players in the years ahead.
And then there’s the commercial mortgage-backed securities (CMBS) market. It, too, was all but given up for lost in 2000. Things really weren’t so bad, and this year is looking a lot better.
Still, there is reason to tread carefully. Perhaps New York-based Ernst & Young sounded the note of caution best in its annual update on the CMBS market: “The most pressing issue on everyone’s mind is the imminent end of the good times in real estate, the inevitable down cycle that may finally be upon us. Excruciating diligence in underwriting commercial mortgages has never been more appropriate.”
Thomas Jaekel, managing director in charge of Chicago-based Cohen Financial’s merchant banking unit, sees plenty of volatility in both the debt and equity markets right now. “On the debt side, the traditional yield curve was inverted during the first quarter, with 10-Year Treasuries below short-term interest rates,” Jaekel said. “This inversion led to an increase in long-term, fixed-rate financing.” In fact, about 70% of Cohen Financial’s first-quarter business was fixed rate, as opposed to 40% fixed and 60% floating for 2000. Jaekel expects the recent interest-rate reductions to keep short-term rates lower, and with them, the shift back to more floating-rate transactions.
Gaylord L. Toft, managing director of investment services at Chicago-based Transwestern Commercial Services, says floating-rate debt has already started to gain popularity.
In many cases, despite the historically low cost of long-term, fixed-rate debt, borrowers have been opting for floating-rate debt since either they expect rates to continue to fall, or they hope not to be borrowers for long, Toft said.
“They opt for the flexibility of pre-payable debt, avoiding the potential for penalties with long-term, fixed-rate borrowing, due to yield maintenance requirements, often planning to return to the equity or for-sale market in the near future, with the hope that equity demand and prices will soon turn up,” Toft explained. “Or they wish to be able to convey assumable, pre-payable debt, which will grant any potential buyer flexibility, so that debt will not represent an impediment to any future equity deal.”
In the bigger picture, Kempner maintains that long term, “we may be seeing a permanent shift toward real estate-based securities, both debt and equity. Many investors and investment managers have received an expensive lesson in the benefits of well-diversified portfolios. What we may be seeing is not a transitory shift toward REITs and CMBS, but a more permanent reallocation toward real estate that should carry through for a number of years, particularly as now-chastened baby boomers facing retirement reallocate toward income-producing securities.”
The CMBS market has ridden one of the wildest roller coasters around, but after a slightly weaker 2000, the sector is poised for a significant comeback.
Going forward, nearly everyone has apartments near the top of their popularity lists. “If I were to pick one property type that was most-favored it would have to be multifamily,” said John Gough, managing director at San Franciso-based LoopLender, the online mortgage origination arm of LoopNet. “Multifamily transactions have become a staple for conduit securitizations, insurance companies and for regional banks alike. Of the 46 loans closed by LoopLender over the last 12 months, 58% have been secured by multifamily property.”
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