Commercial Mortgages: Capital is flowing into real estate

by KW Calabasas on General April 9th has no comments yet!

Bono probably wasn’t thinking about the rebirth of commercial real estate when he sang “After the flood all the colors came out” in U2′s “Beautiful Day,” but the song evokes the budding optimism that can be felt in the industry today.
After four tough years of battles with lenders, tenants and investors, commercial real estate developers seem poised to move beyond their recent past and look toward the future.
What is the reason for this outlook? In a word: capital.
Capital is the life blood of real estate. When it’s flowing, the industry blossoms, and when it’s not, the industry shrivels.
For the better part of four years, capital has been receding from real estate (and other assets); now it is flowing back in.
Bill Gross, the famed head of PIMCO, the world’s largest bond investor, recently released an investment outlook that is a bit scary for investors because Gross predicts that real growth will be severely limited by excessive fiscal deficits and high debt-to-gross domestic product levels.
The good news: Investment real estate, in his view, is one asset class that has the potential to deliver the most return with the least amount of risk. The caveat is that the assets shouldn’t be “burdened by excessive debt and subject to future haircuts.”
Of course, savvy investors have already come to the same conclusion and have been running to so-called “fortress” commercial real estate for several years.
That is, they have been investing in the top buildings in the top markets and using low leverage in their purchases. The thinking is that as inflation kicks in, rents will go up and you will have good returns that are a hedge against inflation.
The only problem with the thinking is that when everyone is trying to buy the best building in the best cities in the country, it is hard to get a price that creates attractive returns.
No matter how attractive a building, every building has a price that is unattractive. That is why investors are now looking beyond “fortress” real estate and exploring secondary markets.
For instance, February sales volume fell year-over-year in Boston, Los Angeles, San Francisco and Washington, but rose in Chicago, Detroit and Seattle, according to research from CoStar Group, a Washington-based real estate information provider.
While one month is hardly a trend, it shows an expected progression in the recovery and has industry participants in smaller cities feeling more upbeat.
A huge help in this trend of capital turning to secondary markets is the availability of debt.
With commercial mortgage-backed security lenders more active and extending their success of the past few months, more money is flowing to a wider range of real estate.
Pricing for five- and 10-year mortgages is now in the 4 to 4.85 percent range, respectively, for solid non-recourse mortgages from life insurance companies and Wall Street conduits (commercial mortgage-backed security lenders), according to the John B. Levy & Co. National Mortgage survey.
Lower leverage deals are priced lower and smaller loans financed with community banks are priced higher.
Rates on commercial mortgages are higher this month than they were last month primarily because yields on U.S. Treasuries have increased significantly. This has occurred because investors have a little more faith in the economy and are willing to look elsewhere for higher returns.
The same is occurring in commercial real estate.
Investors are moving away from “fortress” real estate and into secondary markets to get better returns.
Richmond should be a direct beneficiary in this movement and has already benefited from an increase in debt capital availability.
The question is how long will prices remain attractive while debt remains cheap? As Bono would say, “It’s a beautiful day, don’t let it get away.”


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