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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 2015

Financial Market

Eric Tupler

Senior managing

director, HFF,

Denver