Commercial Investment Real Estate November/December 2018 | Page 37

When a correction in the market will come is uncertain. When it does occur, it will look different than the last one. It will not be a highly levered capital markets across-the-board implosion like last time. Some major private equity funds are out raising capital, some of the largest amounts that they have ever raised — perhaps either to buy, to bet on further improvement, or in anticipation of distress. The capital will be available, along with the technology to analyze deals quickly, and the experience and wisdom gained from the last implosion. Constantine Korologos, CRE, MAI, MRICS, is an independent real estate advisor and an adjunct professor with New York Univer- sity’s Schack Real Estate Institute. Contact him at tinokorologos@ gmail.com. Where Is the Supply and Demand? by William G. Leffew, CCIM Supply and demand for real estate capital follows two basic avenues. First, who is borrowing and what are their goals for a real estate asset? Second, who is lending and what are their observations and perceptions of both the market and a specific asset? According to the June 2018 Federal Reserve Release of Mortgage Debt Outstanding, commercial banks account for $2.16 trillion of the $4.1 trillion of multifamily and commercial mortgages outstanding in the U.S. The remaining half is split between government-sponsored enterprises ($703 billion), commercial mortgage-backed securities ($375 billion), life companies ($394 billion), and other lenders ($474 billion). Borrowers with short-term goals desiring prepayment flexibility typically want to stay on the short end of the yield curve. Unfortunately, with Federal Open Market Committee increases to Fed funds, prime and Libor have soared to levels not seen since April 2008 and November of 2008, respectively. In other words, it’s expensive to stay short term. Borrowers with long-term goals, however, have benefited from a rather stable U.S. Treasury and reduction in loan spreads from the GSEs, life companies, and CMBS lenders. Furthermore, the desire for loan yield and liability matching (whole life and long-term care policy issuance) produced the need for longer loan durations among life company lenders. The result is non-recourse 10-year loan terms still in the mid-4 percent range compared to short- term, recourse bank debt in the 5 percent range. Despite the rollback of some Dodd-Frank provisions, commercial banks remain stingy, with construction dollars preferring to stay at the 75 percent or less loan-to-cost level across most property types. Performance of construction loans and their underlying collateral in terms of lease-up at pro forma rents continues to be a focus of commercial bank lenders. Solid projects achieving pro forma levels are quick candidates for sale or the permanent market. Retaining these assets on the bank’s balance sheet requires lenders CCIM.COM to deviate from their short-term, recourse nature in favor of traditionally permanent market deal terms. The result often can yield loan exposure issues not just in terms of commercial real estate, but also specific property types, tenant exposures, and borrower concentration. What’s in Demand? Favored property types continue to be multifamily (market rate and affordable), industrial, and grocery-anchored retail. Box-style retail, unanchored retail, suburban office, and hospitality are challenging asset types unless financed at a lower leverage level or with some personal recourse. From a demographic and debt perspective, affordable multifamily projects are in demand. New class A multifamily construction at higher rent levels may be the only option to offset higher construction costs. However, it’s important to note the rate discounts offered by Fannie Mae and Freddie Mac on affordable (defined as those with rents at 60 percent of area median income or lower) multifamily projects. GSEs don’t have to count these financings against their annual production allocation from their regulator, the Federal Housing Finance Agency. These projects fulfill their affordable-housing mission and also are defined as uncapped business, resulting in the prevalence of interest spread discounts of 10 to 25 basis points. On the institutional side, trophy-quality assets in top 25 momentum markets continue to be the focus. Many of these assets are at lower leverage levels and garner superior pricing and structure focused on cash flow yield to investors. At lower leverage points (less than 50 percent loan-to-value), buyers are employing interest-only structures designed to boost yield as an offset to paying aggressive cap rates at acquisition. William G. Leffew, CCIM, is senior vice president at Bellwether Enterprise Real Estate Capital in Louisville, Ky. Contact him at [email protected]. November | December 2018 35