Colorado Real Estate Journal - February 18, 2015
If our current environment is “the new normal,” then for the foreseeable future, it is locked into a state of volatility and inconsistency. In a way, it parallels a principle of chaos theory: a butterfly flaps its wings in the United States, which results in a hurricane in China. However in this case, the butterfly can be one of many things; ISIS, Greece, the Ebola Virus, OPEC, Russia, the Federal Reserve, etc. The consistent theme is that each of the above has impacted our markets throughout the last few years. In our forecast last year we highly anticipated, along with most every market analyst, that going in to 2015 the 10-year Treasury would be well north of 3 percent. On the contrary, last month witnessed yields as low as 1.65 percent, keeping the lending environment quite favorable for commercial real estate investors. Just how long will this last? The message from the 2015 Mortgage Bankers Association Commercial Real Estate Finance conference held recently in San Diego was overwhelmingly positive. As an asset class, real estate continues to be a top performer with little to no erosion in market fundamentals on the horizon. Vacancy rates are low across the country, rents are rising, and outside of multifamily, there does not seem to be fear of an oversupply issue in the near term, since development activity is still below historical norms. In spite of the volatility the Federal Reserve is expected to raise rates sometime this summer, driving investors to move quickly on acquisitions and refinancings while they still can. CBRE’s Debt & Structured Finance group had a record year with $33.2 billion in originations nationwide, up from $25.7 billion in 2013. Again, multifamily led all asset classes with an extremely competitive appetite from agency lenders (Fannie Mae, Freddie Mac), as well as life insurance companies, banks and commercial mortgage-backed securities lenders. Freddie Mac and Fannie Mae are offering long-term options with a LIBOR-based floating-rate component, as well as forward index locks to mitigate the risk of rising interest rates. While cap rates continue to compress in this space, effective interest rates in the 3.25 to 3.5 percent range allow for positive leverage right out of the gates. Life insurance companies, typically the most conservative lenders in terms of underwriting, have set higher allocations once again for 2015 and are enjoying a competitive advantage with their ability to lock a forward interest rate up to 18 months in advance in some cases. Interest rate floors in low- to mid-3 percent range are achievable in the current rate environment and a number of investors with looming maturities in the next two years are expected to hedge by entering forward rate locks. The sweet spot for life companies continues to be in the 55 to 65 percent loan-to-value range with interest-only periods available for lower-leveraged deals. The commercial mortgagebacked securities space is the most competitive lending environment with over 40 different originators in the market. Over $90 billion in securitized loans were originated in 2014 with outputs in 2015 expected to be well north of $100 million. Recently, CMBS originators have tried to separate themselves from the pack by stripping away onerous cash management structures and offering lengthier interest only periods. The new metric in CMBS 2.0, the debt yield, has also compressed, which is the most unnerving sign that underwriting standards are softening back to pre-2008 levels. Nonetheless, demand for CMBS paper ebbs and flows with market events. For example, CMBS originators have responded to the dip in oil prices by putting new issuances on hold in energydriven locations. Over the next three years, we will see a steady stream of sale and refinance activity with $325 billion in outstanding debt maturities due in 2015, $368 billion in 2016 and $423 billion in 2017. A rising interest rate environment will likely have an adverse impact on cap rates and valuations in the commercial real estate arena. But as long as the rise is steady, there is no reason to believe that it will completely stall the market. There may be a few good years left in this current run and our prediction is that 2015 will be fast paced and frothy, albeit with a few bumps in the road here and there.