Capital Markets 2012
What issues are facing the lending market this year?
Many economic issues converged late last year to slow commercial real estate's
recovery. In addition, the uncertainty of vintage commercial mortgage-backed securities
loans coming due this year and for the next several years has buyers, sellers, and
investors speculating on the continuing availability of capital. To get a clearer
picture of the capital markets' activity this year, Commercial Investment Real
Estate asked an economist and two mortgage banking executives to weigh in on the
is manager of quantitative and commercial
research for the National Association of Realtors in Washington, D.C. Contact him at
is principal and managing director for George
Smith Partners, a real estate investment banking firm located in Los Angeles. Contact
him at firstname.lastname@example.org.
James R. Kirkpatrick, CCIM, is vice president of production
for Grandbridge Real Estate Capital in Houston. Contact him at
More than $55 billion in CMBS loans are set to mature this year, the most of any
year to date, according to Standard & Poor's. Of them, $19 billion are
five-year loans originated in 2007, at the height of the market. How is this going to
affect the lending environment for commercial real estate?
George Ratiu: The main impact of maturing debt will be felt in the banking
sector, which has had to contend with these loans for the past three years. And based
on both bank practice and regulator guidance, banks have been extending or
restructuring loans based on multiple factors, such as asset performance, market, and
management. Overall, given banks' post-financial crisis aversion toward
commercial loans, the lending environment will likely remain tight in 2012, with
private and equity capital continuing to serve as the main source of funding.
David Rifkind: 2012 is the beginning of the refinance wave, fueled by
historically low interest rates. The peak will be somewhere between fourth quarter 2013
and second quarter 2014. Every healthy lender is prepared to compete for a piece of
this business. We are actively tracking maturities for our clients. This is the leading
theme of the mortgage banking business for the near and intermediate term.
Jim Kirkpatrick, CCIM: The bottom line is that in a yield-hungry world, real
estate is looked upon favorably. A lot of lenders are underallocated in real estate and
we are seeing new CMBS platforms emerging. Assuming continued economic growth, the
lending environment for the foreseeable future should remain strong.
As this tsunami of loans continues, reaching its peak in 2017, will it have any
other effects on the commercial real estate market? Will specific capital sources,
cities/regions, or property types be affected?
Ratiu: Some of the effects have been manifesting over the past year. Capital
has been chasing high-quality, stabilized properties in gateway cities such as New
York, Boston, San Francisco, Washington, D.C., and Chicago. This has led to an increase
in prices in these markets and a decline in capitalization rates.
Secondary and tertiary markets have been contending with a lack of financing due to
the underlying strength of local economies and weaker fundamentals. As the supply of
investment-grade properties in top markets dwindled, some secondary markets became
attractive to investors looking for higher yields. A broad improvement in macroeconomic
conditions will likely boost this trend, providing increased flows of capital to these
Rifkind: The maturity wave is drawing money and attention back to the
commercial real estate markets. Three themes are converging to create what may become a
powerful new market cycle. First is low rates/liquidity: Capital is aggressively
seeking yield at every point on the risk curve. Banks must book positive loan growth
and many are aggressive. Life companies and pension funds have reallocated large
amounts of capital to commercial real estate. CMBS wants to come back and be a force in
the real estate capital markets. Opportunity funds and real estate investment trusts
are innovating to participate higher up in the capital stack.
Second is the return of fundamentals. Rents and occupancy levels are stabilizing in
many markets. With little new supply over the past five years, there is a solid case
for a positive trend in property performance. The distress theme is still relevant and
there will still be transactional opportunities motivated by debt maturities. This is
especially true for properties in markets where fundamentals have not yet recovered to
a level to qualify for loans from the primary debt providers.
There is enough liquidity to address the capital needs of the market going forward.
As long as the underlying fundamentals continue to improve, we should see a robust
recovery in many markets.
Kirkpatrick: I am based in Texas and we have been blessed with a strong
economy and the accompanying job growth. Going into the recession, we had very little
overbuilding so our real estate markets are in fairly good shape. Most of the refinance
opportunities we are seeing will underwrite and those that don't can mostly be
accommodated with some of the new mezzanine platforms that are coming out. In other
words, the owner does not need to write a check to get their loan refinanced.
I wish I could say our good fortune extends across the country, but my guess is that
it doesn't. Those loans maturing in 2012 that were originally highly leveraged or
with little to no amortization over the term and in regions of the country with limited
economic growth/high unemployment are probably going to require the infusion of some
fresh equity to get them refinanced. Therefore, by extension, the ability of ownership
to write these checks could impact real estate values.
What other factors are affecting the capital markets this year?
Ratiu: The European banking concerns will likely remain a major factor for
U.S. capital markets. Some U.S. banks do have exposure to European sovereign debt,
which will likely impact their overall willingness to extend capital for commercial
projects. In addition, the Dodd-Frank Act and the yet-to-be drafted regulations will
continue to provide a source of uncertainty in 2012, as regulators work to enact and
implement new rules. Against this backdrop, commercial banks are expected to remain
cautious on commercial lending.
Rifkind: The leading factors are macroeconomics and politics. These are the
same factors that have provided head winds for the past six months. How the European
liquidity crisis plays out is important. The upcoming U.S. elections are
Kirkpatrick: Where are interest rates going? I tend to side with the camp
that says interest rates have to go up, but as I write this, the benchmark 10-year
Treasury is 1.97 percent, virtually unchanged from August when Standard &
Poor's downgraded U.S. credit. Sticking to my guns, when rates do go up, a steady
climb can be accommodated, but sharp spikes, particularly in some of the short-term
money such as Libor, could wreak real havoc.
In addition, continued growth of the CMBS markets will affect capital markets, but more
to the point, what is the underwriting that will be necessary to drive this growth?
Will buyers and investors have difficulty finding financing in 2012?
Ratiu: Given the 2011 bifurcation in commercial markets along property
values, buyers at the top end of the market will continue to find access to financing
in 2012. With record amounts of cash and the ability to issue bonds or equity for
financing, large corporations and equity funds are expected to remain active in the
market this year. Buyers at the other end of the valuation spectrum will likely
encounter a similar environment in 2012 as last year: restricted capital availability,
relatively tight underwriting standards, and a higher risk aversion on the part of
Rifkind: Buyers will have less difficulty finding financing this year.
Qualifying for new loans will remain difficult for some. Credit requirements remain
strict. Borrowers need strong reserve liquidity and credit to obtain loans. Property
level underwriting is also very conservative and leverage will remain relatively low,
requiring a larger equity contribution from the buyer. Ultimately, this is healthy for
the markets and I hope lenders will continue with disciplined underwriting standards as
competition for loans heats up.
Kirkpatrick: There should be plenty of money available to refinance those
loans coming due, as well as to finance new acquisitions or development. At the end of
the day, the real question is whether or not the owner/borrower is prepared for all of
the scrutiny associated with borrowing in today's environment.
While the general economy seems to be recovering at a quicker pace than originally
predicted, commercial real estate activity retreated during the second half of 2011.
What is the cause of the disconnect between the two? What factors may spur a similar
uptick in commercial real estate's recovery this year?
Ratiu: Commercial real estate investment activity tends to be more sensitive
to developments in financial markets. As the European sovereign debt crisis unfolded,
it took a darker turn in the second half of the year. Concern of a resolution moved
farther away, prompting capital markets and investors to scale back the pace of
acquisitions.In addition, until the tail end of the year, stubbornly high
unemployment figures remained at the forefront of economic news, as signs of a robust
recovery proved feeble. Moreover, actions in the international and political
environment added reasons for investor concern.
For 2012, a continuing rise in economic growth coupled with improving fundamentals
in commercial markets would go a long way toward shoring up last year's moderate
rebound. In addition, the prospect of the resolution of the presidential election cycle
is likely to provide a clearer medium-term horizon for investors.
Rifkind: I don't see a disconnect. The U.S. economy slowed
significantly in the second half of 2011. Commercial real estate activity also slowed
down from its initial burst of activity. Capital markets' volatility came into
play in the middle of 2011 with the debt ceiling debate and the downgrade of the U.S.
debt rating. This was followed closely by Greece and the EU liquidity crisis. This
raised the caution flag and slowed activity.
Commercial real estate is a long-term store of value and not a quick trade. It is
difficult to view it with a short-term lens. Recoveries are not always linear. 2011 was
no exception. The market healed significantly in 2011 and this trend will continue.
Kirkpatrick: In my opinion, the disconnect between the improving economy and
the retreat of commercial real estate activity was the result of two factors. Too much
money was chasing those deals that came to market. With all of this competition, the
result was predictable: Prices increased and yields fell. In the latter part of 2011, I
think many investors decided to take a step back to see if rent growth would actually
materialize to justify the going-in yields being paid.
Then, after a fast start in 2011, the CMBS market stumbled — many
of the new CMBS platforms shut down, some commitments were not honored, and for those
that remained, spreads widened dramatically. The message here is that CMBS is an
important part of the commercial real estate equation.
The good news is that the U.S. economy continues to improve. Jobs are being added,
which in turn will lead to increased demand for commercial real estate. It will just be
a matter of time before investors return to the market. On the debt side, CMBS has
settled down. Spreads have come in and investors seem to have reached a comfort level
with current underwriting. Banks and life insurance companies seem to be actively
pursuing new lending opportunities. I wouldn't look for a return of 2006, but
2012 has the makings of being a solid year for commercial real estate.
This article was edited by Sara Drummond, executive editor of Commercial Investment