The capital markets play a significant role in the investment and continued growth of the commercial real estate sector. The outlook of the financial landscape and what we can expect from the capital markets in 2016 has a significant impact on investment decisions this year.
In 2015, we saw a stable, strong financial landscape with ample capital sources available to meet the demand and the continued growth of the market. However, the question remains - What can we anticipate from the capital markets in 2016?
brief overview of the dynamics that will likely impact 2016’s financial climate is based on 42 years of
experience in providing financing throughout the real estate industry.
Availability. The number of capital sources available will remain strong
throughout 2016. With that said, we will continue to see the gap widen between
the costs of capital available in major metropolitan areas and in small metros.
the large national lenders have been investing and will continue to remain
active in U.S. major metropolitan markets, with the small exception of those
heavily influenced by oil. Regional and local lenders will remain the option
for the smaller metro areas.
division of investor size creates a disparity in costs. Smaller markets have a
higher cost of capital than larger markets due to the lack of competition from
large, national lenders who choose not to operate in those smaller areas.
Rates. As we closed out 2015, the Federal Reserve began its first steps in
increasing short-term interest rates and predicted future increases throughout
the new year. Because real estate pricing is more heavily tied to long-term
rates, we anticipate that this initial move by the Fed to increase short-term
interest rates may not have a significant impact on commercial and investment
real estate lending.
when the Fed announced the short-term rate increase in December 2015, the
10-year Treasury bill was at 2.30 percent. As of January 25, it was at 2.01
percent. The long-term Treasurys have become a global option that is often
influenced by many factors unrelated to U.S. short-term rates.
this in mind, the recent increase in short-term rates or a slight increase in
short-terms rates throughout the course of the year will not have a significant
effect on capital markets in 2016.
Capital. Spreads that previously increased or widened in the third and fourth
quarters of 2015 have subsequently decreased, leading to a lower all-in rate or
total cost of a mortgage in 2016.
example, large life insurance companies providing financing on large
low-leverage loans at the end of 2015 were originated at prices with a 1.90
percent spread over a 2.30 percent 10-year T-bill for an all-in rate of 4.20
percent. As of late January, the pricing is 1.65 percent spread over a 2.01
percent 10-year T-bill for an all-in rate of 3.66 percent.
supports the thought that we should be careful assuming the cost of capital
will definitely increase in 2016. That being said, the stricter risk retention
legislation and regulations affecting the commercial mortgage-backed securities
market will add cost to the CMBS process, potentially affecting the cost of
capital in 2016. To what extent these changes may impact the cost of capital is
yet to be seen, but it is important to keep in mind when determining the
anticipated cost of capital this year.
Sentiment and Focus. A December 2015 survey of the 60 top commercial and
multifamily mortgage origination firms by the Mortgage Bankers Association
found that 97 percent of respondents expect lenders to have a strong or very
strong appetite for loans in 2016. In addition, 67 percent of these respondents
anticipate volume to increase by approximately 5 percent over 2015 levels.
sentiment by the top commercial and multifamily origination firms is consistent
with 10 institutions we surveyed directly. Each of the firms surveyed further
concluded that they also anticipate strong growth in terms of the number and
volume of loans originated in the new year.
major investor groups — banks and thrifts, CMBS, agency/GSEs, and life
insurance companies — represent 86.2 percent of the $2.76 trillion of current
outstanding debt on commercial and multifamily properties. The majority of the
respondents to the MBA survey feel that this is in large part due to the high
levels of maturing loans that were originated in 2006 and 2007, coupled with
the strengthening U.S. economy.
this sentiment, investor groups should continue to diversify their portfolios
by being both geographically and product-type diverse in 2016. The portfolio
lenders with a finite allocation are particularly careful of both geographic
and product-type concentrations. They are sensitive to wisely assure their
investments are appropriately spread between multiple geographic regions and
multifamily and industrial will continue to be the most widely sought-after
asset classes. While office and retail are also desirable investments, these
product types require a more careful underwriting process, taking into
consideration tenant quality and lease rollover exposure.
Sentiment and Focus. This year, the four different investor groups will bring
varying advantages to the capital markets — both complementary and
and thrifts bring local knowledge, flexible terms, and a commitment to their
trade area. A good example is the coastal communities where rent and values
exceed most other markets. The local banks and thrifts that are in these
markets are comfortable with the higher loan per square foot for those property
owners seeking higher leverage and loan-to-values. However, due to their cost
of funds, their terms tend to be shorter and rates slightly higher.
market has provided an infinite amount of capital to the real estate industry.
Although occasionally cyclical and volatile, the CMBS market has met a demand
for the higher-leverage borrower seeking to maximize loan proceeds or
properties that don’t fit
the investment criteria for the other investor groups at very reasonable rates.
and GSEs, such as Freddie Mac, Fannie Mae, and the Department of Housing and
Urban Development, have always been the best alternative for the better-quality
multifamily asset class.
insurance companies, although the smallest of the commercial and multifamily
investor groups, have always been the “best terms” alternative.
Due to their cost and availability of managed funds, property owners with good
quality assets seeking lower leverage for the longest terms at the lowest rate
would most probably find the life insurance companies their best option.
example of complementary and competing options is a recent transaction in which
our firm was hired to replace the maturing loans that we had placed on a
portfolio of 12 shopping centers in Southern California 10 years ago. The $154
million portfolio of loans ranged from $5 million to $36 million, with
loan-to-values ranging from 50 to 75 percent. The loans also ranged from
10-year terms amortized over 30 years to 20-year terms fully amortized. In the
current market landscape, we found that the best option for our client was to
place this request with four different sources: two life insurance companies
and two CMBS lenders. By doing so, we were able to secure financing that met
current needs, while also utilizing the variety of benefits provided by these
varying capital sources to complement one another to our client’s advantage.
Overall, based on the continued strong market
fundamentals including availability of capital, low long-term interest rates,
and the still low cost of capital, the 2016 capital markets will remain healthy
and provide an opportunistic environment for continued growth and investment
within the real estate sector. In addition, investor groups will remain
vigilant in diversifying their portfolios both geographically and by product type,
while owners and investors seeking to invest in real estate will continue to
benefit from the diverse range of capital sources available.
Lending Ends on an Upswing
“We saw strong volumes of borrowing and lending for commercial real
estate in 2015 and in particular in the fourth quarter,” said Jamie Woodwell, vice president of
commercial real estate research for the Mortgage Bankers Association. “In fact, 4Q15 was the fourth highest quarter
for borrowing and lending on record. Banks, life insurance companies, and
Fannie Mae and Freddie Mac saw their highest originations volumes on record. Of
the major investor groups, only the CMBS market didn’t break a record for originations. In terms of
overall borrowing and lending volumes, 2015 as a whole was likely second only