Western Real Estate Business

OCT 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

Issue link: https://westernrealestatebusiness.epubxp.com/i/1037966

Contents of this Issue

Navigation

Page 48 of 56

48 • October 2018 • Western Real Estate Business www.REBusinessOnline.com EXPERTS REMAIN CONFIDENT FINANCIAL FUTURE FEASIBILITY WILL CONTINUE Interest rates are increasing, but 10 years on from the start of the previous recession, experts believe our industry will weather any storms with increasing resilience. CRE LENDING LOOKS STRONG 10 YEARS AFTER LEHMAN COLLAPSE By Bryan Cavalier, Managing Director of Real Estate Finance, CIT Group in Los Angeles Things are look- ing bright for com- mercial real estate in the Western U.S., and it's not just be- cause of our sunny skies and beautiful sunsets. Our current national econom- ic expansion has now been under- way for more than nine years, albeit at growth rates more subdued than past recoveries. This economic growth has been sup- ported in part by a booming technol- ogy sector, consumer demand buoyed by a strong labor market, rising prop- erty values and tax cuts, and a bull market in stocks that has resulted in the longest period of uninterrupted gains in American history. In fact, the S&P 500 index has more than tripled since it bottomed out in March 2009. It's almost enough to dim memories of the financial crisis that preceded this expansion. All those memories came flashing back earlier this month, however, on the 10th anniversary of the Lehman Brothers collapse, an event that trig- gered the financial crisis and subse- quent Great Recession. This also made me realize how far our industry has come in the decade since. A Rebound Abounds Real estate prices have rebounded and now surpass pre-recession highs. Commercial real estate supply in all property sectors has been relatively constrained during the recovery, as developers and capital provid- ers were careful to avoid speculative building. More recently, however, in- creasing supply — especially in Class A multifamily and office — has begun to exceed demand, putting the brakes on rent growth. Meanwhile, a revitalized technol- ogy sector, combined with the re- emergence of and re-investment in urban cores, has led to innovative new projects. A re-thinking of or- ganizational space has driven huge demand for creative office locations with open floor plans and communal work areas. Compared to a decade ago, real es- tate borrowers today have access to an ever-broader menu of options when it comes to financing. These include not only senior debt, but also mezzanine debt and preferred equity. What is also different this time around is that today's commercial real estate deals depend on the borrower having enough equity in the property to weather an economic downturn. This reassures lenders that their loans will either be repaid via property sale or refinance. Lenders Remain Disciplined From the bank lender standpoint, credit standards have remained strong and leverage levels have held steady. This has occurred even as liquidity abounds, interest rates slowly rise and competition squeezes margins. It's a testament to their credit discipline that most lending institutions are willing to watch spread compress rather than increase leverage or loosen their cred- it standards. Banks are ceding higher leverage and higher risk deals to the plethora of debt funds in the market, and are unwilling to risk weakening their strong balance sheets. Confidence in the Capital Markets All this reflects a more mature capi- tal markets environment. A correc- tion, if any comes, should be manage- able. That gives me confidence in the future. The health of the lending com- munity provides valuable support for the commercial real estate sector and, through it, the economies of many Western states. Consider, for example, the latest findings of the CBRE "Investor In- tentions Survey," which reflects the sentiments of 300 real estate inves- tors. It found Los Angeles/Southern California is the top-ranked metro area for property purchases. Dallas/ Ft. Worth came in second place. Seat- tle and New York were tied for third, followed by San Francisco/Northern California and Houston, which were tied for fourth. The Western U.S. is well represented among those top-tier markets. Of course, there is variation across the different commercial real estate sectors that is driven by customer demand and the ongoing shift from brick-and-mortar retail to ecommerce. Industrial and multifamily sectors are particularly strong, according to the California Commercial Real Estate Survey and Index, released in July by the Allen Matkins/UCLA Anderson Forecast. However, the office market and retail sectors have lagged, given slowing absorption and chain-store retailer woes. The abundance of capital means most deals in this market can find the right mix of capital suitable for the business plan and risk. In this matur- ing real estate cycle, borrowers and lenders need to work closely with people who have the experience, ex- pertise and relationships to structure transactions that are appropriate for the risks. Real estate is a dynamic business and still subject to market cycles, so it's always wise to tread cautiously. Even so, I'm optimistic that key mar- kets across the West are home to solid demographic and demand fundamen- tals. There are still plenty of projects waiting for the right combination of capital and expertise to unlock value. THE IMPACT OF RISING INTEREST RATES ON CAP RATES By Tomi Jo Lynch, Managing Director of SVN | Gold Dust Commercial Associates in Reno, Nev. Among many fac- tors that influenced the recovery of the commercial real es- tate market nation- wide were the his- torically low interest rates that occurred coming out of the recession. These low rates played no small part in help- ing the economy recover as a whole. Now that the econ- omy has shifted, these rates will change. As we look to the months and years ahead, investors are keeping a close eye on any impacts on property prices and cap rates as interest rates rise due to anticipated actions by the Federal Reserve in the short-term, as well as market-driven changes in the long-term. The Inevitability of Rising Interest Rates We know interest rates will go up. What remains to be seen is the degree of impact on cap rates and by exten- sion, on property values. The textbook relationship between interest rates and cap rates is clear. As the cost of financing increases, cap rates are ad- versely affected, which, in turn, can lower property values. While reasonable, this has not al- ways been historically true. The re- lationship between interest rates and cap rates is complex. Looking at in- terest rates alone doesn't take several factors into account that have the po- tential to minimize the impacts of a higher cost of financing on property values. The most significant of these factors is the cause of the rising inter- est rates. Low interest rates are a sign of a weak economy and used to stimulate economic growth. In our current envi- ronment, rates are rising in anticipa- tion of a continued strengthening of the economy and expected low rates of unemployment. Both of these fac- tors support property values. Secondly, from small family offices to large acquisition funds, cash buy- ers are plentiful. This buyer profile is more concerned about deploying capital and meeting minimum cash- on-cash return expectations and less concerned about their levered rate of return. Commercial real estate re- mains a safe place for investors to place capital and to create cash flow for many buyer types. Lending Competition Remains Strong An even distribution of capital sourc- es from CMBS lenders to private mon- ey have created healthy competition amongst financing sources. Instead of increasing rates, lenders have become more competitive on other loan terms, such as broker fees, discount points and closing costs. Although interest rates are going up, mortgage rates have not yet skyrocketed. The timing of cap rate increases can influence outcomes as well. If unem- ployment remains low, tenants will have increasing space requirements and, in turn, a shortage of available vacancy and rising rents. Rising rents can help Net Operating Income (NOI) keep pace with increases in interest rates if anticipated and accounted for. Cap rates have varied across market sectors in 2018, with the high being in the hotel sector and the low in apart- ments. Rates for retail, office and in- dustrial have maintained near all-time lows as well. These low cap rates have bolstered the commercial real estate market against small rises in interest rates. The national market is seeing cap rate compression across the board, with secondary and tertiary mar- kets offering buyers some insulation against potentially rising interest rates and declining values. Tertiary and sec- ondary markets like Reno generally have less volatility and economically tend to trend a few years behind ma- jor markets. If a spike in interest rates Bryan Cavalier CIT Group Tomi Jo Lynch SVN | Gold Dust Commercial Associates

Articles in this issue

Links on this page

Archives of this issue

view archives of Western Real Estate Business - OCT 2018