Commercial Investment Real Estate November/December 2018 | Page 36

National Commercial Property Price Index
2003 to 2Q18 (All Property)
175
Major Markets
National
Non-Major Markets
150
125
100
75
50
25
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Real Capital Analytics
double again this year. In addition to the securitized floating rate
product, bridge lenders have liquidity to provide anywhere from $3
million loans to $500 million loans. Sponsors who raised capital
range from smaller debt funds to multibillion-dollar private equity
funds and global asset money managers. Even traditional develop-
ers who aren’t finding the yield they seek on the equity side of the
balance sheet are entering the lending market.
Public REITs also have been active in the lending space. Black-
stone, Starwood, KKR, ARES, and TPG all created publicly
traded mortgage REITs to tap the demand for liquid high-quality
mortgage investing. Some of these individual REIT loan invest-
ments exceed $500 million, illustrating the scope of the current
mREIT market.
When including traditional money center banks, regional and
community banks, insurance companies, and foreign banks and
institutional investors — all of whom continue to lend actively —
it’s clear that the debt markets are not suffering from a liquidity
shortage. But too much liquidity in the system isn’t necessarily
a good thing.
What’s in Store for 2019?
As the market moves into eight years of a strengthening real
estate cycle, remember that recoveries are not consistent. While
both major and non-major market property categories have
surpassed the prior peak, a significant spread exists between
the major and non-major categories. Drilling down further,
multifamily markets have shown the greatest recovery, while
suburban office and retail have shown the least. On a national
basis, retail is the only major category that has not returned to
its pre-financial crisis level.
While the fundamentals still appear strong, at some point
the band will have to take a break. The recent tax reform bill
injected some energy into the system, but the effects will wear
off. Transaction volume year-over-year has declined, according
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November | December 2018
to Real Capital Analytics, and much of the
2018 volume has been portfolio- and entity-
level deals.
Interest rates. Rates continue to move
up slowly, potentially impacting the ability
for assets to be financed. However, in the
two and a half years leading up to the end
of 2007, the 10-year Treasury averaged 4.65
percent, ranging between 4.1 percent and 5.1
percent; in 2018, the 10-year hit 3 percent,
according to Real Capital Analytics. That’s
still a 150-basis point difference. As for the
spread between cap rates over Treasuries for
commercial properties (excluding multifam-
ily), the average for that same 2007 period
was 2.1 percent, while the average for the
2015 2016 2017 2Q18 first seven months of 2018 was 4.7 percent.
Looking at average cap rates for these respec-
tive periods, the prior peak is only about 30
basis points higher on average. When looking at Treasuries and
real estate spreads, there is room for movement.
Another indicator of room for further rate increase is the spread
of historic mortgage rates and the 10-year Treasury. During the
same two-and-a-half-year period, the spread ranged from 80 basis
points over the 10-year up to 230 basis points, spiking over the
last five months of the year, when the capital markets started to
face significant challenges in the subprime residential and collat-
eralized debt obligation space. The average, excluding those last
five months, was a little over 100 basis points. In comparison, the
mortgage rate spread to Treasuries is just shy of 200 basis points
during the first seven months of 2018.
In short, interest rates need to be on the radar going forward,
especially when looking at refinance risk for shorter term bridge
loans that assume some repositioning of an asset.
Current expected credit loss standards. Beginning in mid-
December 2019, the new Financial Accounting Standards Board
reporting for the accounting of credit losses for certain instru-
ments takes effect. The new measurement is based on expected
losses, commonly referred to as the CECL model. It applies to
financial assets measured at amortized cost, including loans, held-
to-maturity debt securities, net investment in leases, and certain
off-balance sheet credit exposures, such as loan commitments.
While not a regulatory change, it is a financial reporting change,
and it could have significant implications to lenders — banks,
funds, or anyone who has financial assets like commercial real
estate loans. Firms need to reserve from the date the asset is origi-
nated using a repeatable, defendable, and supportable process, so
that in the event that losses do occur in the future, a reserve has
been captured based on a consistent model over time. The impli-
cations are tough to measure in terms of implementation costs,
requirements, and timing. The challenge for external auditors will
be to look for documentation and evidence used by management
in preparing their estimates.
COMMERCIAL INVESTMENT REAL ESTATE