The Real Estate Capital Scoreboard® – May 2008
Chicago, Illinois, May 1, 2008 – The realty capital markets still are dislocated as investors try guessing the direction of interest rates and namely, mortgage spreads. While negative news abounds, the markets are actually showing signs of calmness as CMBS AAA securities and overall mortgage spreads continue narrowing.
Key market highlights include:
Rate Movements – During April any savings in mortgage spreads were absorbed by overall benchmark rate increases. Bottom line? Mortgage rates are about 25 basis points higher across the board.
Mortgage Spreads – As previously mentioned, spreads tightened permanent loans, resulting in 10-year mortgage pricing at nearly identical levels versus March. However, many lenders retreated from providing competitive five-year loans by widening spreads as much as 50 basis points, resulting in minimal price savings between these two maturities.
The “E” Word – Lenders demand “equity” in nearly every income-producing funding opportunity. Borrowers seeking maximum leverage are plagued with 65% loan-to-value restrictions and stringent debt service coverage minimums. Alternatively, loan-to-cost and refinancing-of-existing-debt tests are added as extra performance thresholds. In other words, equity requirements override pricing considerations and other underwriting terms.
Actual Cash Flow – Proforma income projections and other future-value economics are dramatically discounted as funding sources need to see actual cash flow. As such, new construction projects require substantial preleasing (e.g. 60%+) and substantial equity, typically 30% on cost. Lenders are seeking “flight to quality” transactions with established borrowers willing to provide necessary recourse and guarantees.
Yields - Now more than ever, investors expect to be paid for risk. Although exceptions apply, overall capitalization rates and return-on-cost yields have widened by at least 50 basis points or more. As for mezzanine and other higher-risk funding vehicles, double-digit yields are the norm.
John Oharenko, a member of the Real Estate Capital Institute’s Editorial Advisory Group,
remarks, “Without question, the most profitable and illiquid component of the real estate capital stack is mezzanine debt. In many cases, developers and property owners find it more attractive to lend mezzanine funds as opposed to directly purchasing properties.” He adds, “This phenomenon is short-term as more liquidity will return to the marketplace in the near future.”