January 2015 — Office Properties Quarterly —
Page 3
A
s we approach the start of
2015, the overall health of the
commercial real estate financ-
ing market continues to show
significant improvements and
recovery from the downturn experi-
enced in 2009, which was the low point
in the cycle with only $83 billion of
originations. 2013 total originations sur-
passed $350 billion, and so far year-to-
date 2014 originations are up 5 percent
from the same period in 2013. Although
originations are still well behind the
peak of $510 billion reached in 2007,
the trends over the last three years
are extremely positive and provide
the needed liquidity to support strong
growth for commercial real estate.
Most importantly, debt is available
from a magnitude of sources, including
life insurance companies, commercial
mortgage-backed securities lenders,
banks and bridge lenders. Addition-
ally, financing for office properties is
readily available from all these groups
and as an asset class has witnessed the
second-highest volume behind multi-
family.
Additional comfort can be found in
the fact that current origination volumes
are in line with the amount of current
and future maturing debt levels. Annual
maturing debt levels for the next three
years are approximately $350 billion
each, which is in line with 2013 and
expected 2014 total originations. The
concern of the wave of maturing debt
and inability to refinance in 2009-2010
was greatlymitigated by recent origina-
tion volumes and the fact that most
investors are injecting more equity
into properties instead of leveraging to
the levels experienced in 2006-2007.
Financing Sources
Life insurance company financing
has been one of the most consistent
sources of capital through the recov-
ery. These companies provided 19
percent of the total originations in
2009, which is more than double the
industrymarket share from the 2007
volume of 8 percent. Life insurance
companies’ originations reached a his-
torical record high in 2013 with over
$52 billion, which still represented 14
percent of total originations. Although
the current volume is slightly below
the year-over-year volume for the first
half of 2014, production increased
significantly since that period and it
is expected that these companies will
meet or exceed the 2013 record volume.
Additionally, most life insurance com-
panies are expected to have allocations
for 2015 at or greater than 2014 levels
due to the inability to find similar risk-
adjusted yields in the corporate bond
market and other
investment catego-
ries.
Generally, life
insurance compa-
nies are very active
in financing office
properties, but they
typically look for
high-quality assets
in major markets or
strong locations in
secondarymarkets
and require strong
sponsorship. They
provide the lowest cost of capital but
typically are focused on lower-leverage
opportunities (65 percent or less).
CMBS lenders became more consis-
tent and reliable over the last two years
but continue to ebb and flowwith the
ups and downs in the broader bond
market. Many people have partially
blamed CMBS for the asset bubble
experienced in 2007 when that source
of financing contributed 45 percent, or
$230 billion, of the total origination vol-
ume in 2007. The sector now is signifi-
cantly below those historical volumes
with only $80 billion, or 21 percent, of
total originations in 2013. Year-to-date
volume through the third quarter is up
14 percent from same time last year
with over $68 billion, but it is expected
to finish the year significantly below the
volume projection of $120 billion for
2014.
Despite the volatility in the CMBS
market over the last several years, it
remains a favorable option for financ-
ing office properties. CMBS is cash
flow focused and typicallywill provide
higher-leverage financing options (up
to 75 percent) and lend on assets in sec-
ondary and tertiarymarkets. Although
sponsorship is important, the overall
strength is less critical in attracting this
financing source. Additionally, even
though all-in rates are 25 to 50 basis
points higher than life insurance com-
panies, most groups will provide longer
amortization and interest-only periods.
The bank sector also experienced a
strong recovery and became an active
source of capital within the commercial
real estate industry once again. Gener-
ally, banks have reduced their exposure
and have better balanced their net loans
to total assets, which is currently 52
percent compared with the 2007 peak
in the mid-60 percent range.
Although banks typicallywill seek
partial or full recourse as a require-
ment to lend, they have been an active
financing source for both stabilized and
transitional office properties. Banks
remain sponsorship/borrower focused
and seek shorter-term loans, typically
up to five years, with loan monitoring
throughout the term.
As investors seek yield in the market,
many new lending sources were formed
in 2009-2010 to benefit from the illi-
quidity in the market. They are generally
referred to as bridge lenders and were
formed bymortgage real estate invest-
ment trusts, high-yield funds, credit
companies and private investors. They
often lend short term and target higher
all-in rates, 5 percent to 7 percent. They
typically provide higher leverage than
conventional sources, and lend on tran-
sitional assets and to borrowers with
past credit issues. Bridge lenders have
been a large source of debt for office
properties with high vacancy levels
where there is a clear path to stabiliza-
tion.
Overall, lenders’ demand for office
financing remains strong and we have
not yet started seeing the aggres-
sive underwriting we experienced in
2005-2007. Additionally, many inves-
tors are still seeking lower-leverage
debt packages as the pressure to keep
equityworking has outpaced the need
for higher yields through maximizing
leverage. There is a strong expectation
in the industry that we will maintain this
environment through 2015 and into
early 2016 but longer-term projections
are currently very cloudy.
s
Office financing returns to ‘old’ normal for 2015Financial Market
Eric Tupler
Senior managing
director, HFF,
Denver