2008 Real Estate Capital Outlook – Low Interest Rates and Funding Volume
Orlando, Florida – February 6, 2008 – Lenders gathered in Orlando to discuss various funding programs and the market outlook for 2008 and beyond. The take-home values of the meetings illustrate the following:
- Rate Movements: Market sentiment appears, for the moment, to favor even deeper interest rate cuts [No one was forecasting higher rates].
- Regulation: More regulators are expected to audit banks and other financial institutions this year. Expect tighter underwriting and overly conservative fundings from these sources
- Lower Volume: Some lenders, particularly CMBS players, expect substantial volume drop – as much as 50% or more. Many life companies believe they can reach last year’s target, but are concerned about “relative value” investing. Should lenders “try to catch a falling knife” was a statement made by a life company executive
- Reliability: Certainty of execution is the strongest selling point for borrowers, rather than spread or other pricing variables
- Valuation: Most lenders are pegging values in the 7% or higher cap rate range – need lots of supporting data (recent comps) to justify lower cap rates
- Consolidation: Smaller life companies continue exploring outsourcing and purchasing mortgages instead of direct origination
- Rejected Underwriting: Interest only (except for low leverage), cap rates below 7% (unless strong market conditions or credit tenant), cash-out on cost (no borrower equity in the deal), leverage much above 75% except for apartments, comps and market data older than six months, vacancy calculations below market levels (very few “5%” figures accepted for most commercial properties, projected cash flow modeling vs. income in place
- Watch List: Lodging, non-essential retail, land loans (nearly impossible without recourse), overbuilt markets, and secondary markets. Basically any properties that are not currently cash-flowing and with too much “story”
- Loan size players: $100M+ (balance-sheet life companies – less than a dozen players); $10-30 million (most common funding range for life companies, conduits and banks); Less than $10 (select life companies including small-loan programs and banks)
- Retreating: Wall Street houses, banks and select life companies with sizable CMBS holdings – at least until more loans are removed from balance-sheet
- Treasury Pricing: Wide yield curve, depending mostly on funding source. Life company spreads vary widely from 190 to 275 bps. A substantial gap thereafter as Wall Street CMBS deals are priced on the high-end of the curve starting at 350 bps over treasuries, or 290 bps over swaps for immediate funding loans
- Fixed Rate Floors: 5.5% rate floor for any type of fixed-rate product (regardless of term), except for Agency deals. However most deals are trading 5.75% or more or about 6% rate for most mid-tier life companies. 3% Libor floor setup by lenders to protect floating-rate yields
- “Relative value”: Investment alternatives such as AAA corporate debt trading at 230-240 bps, translating to about 150 basis points over comparable swaps. In a nutshell, insurance companies have this alternative, representing a 60 basis point difference for investment grade bonds versus investment grade real estate debt.