The Real Estate Capital Scoreboard® – July 2009
Chicago, Illinois, July 1, 2009 – While the Fed decides to keep interest rates steady, the capital markets reset property values and debt underwriting metrics to levels not seen in nearly a decade. Meanwhile, lenders focus on recasting legacy deals with preferred borrowing relationships. As expected, new funding opportunities are extremely limited based on highly conservative leverage of 60% or less for commercial properties with capitalization rates in the high single-digit range.
On other hand, apartment financing funds remain readily available via the Agencies at attractive spreads and leverage. However, more submarkets are reviewed for possible downgrades as vacancies continue to rise throughout various parts of the country.
While the market activities are generally slow, especially in the mid-summer months, clear signs of readjusting capital markets are evident as noted by the following dynamics:
- As capitalization rates approached 10% for many type of “Core +” investments, pricing on a per unit basis look “right” according to many investors, yet uncertainty remains with respect to rent growth and tenant retention. The big fear being reduced cash-flow pro forma projections, now known as “re-forma.”
- Landlord underwriting is now an important part of the tenant process to ensure performance on space build-out, payment of commissions and reliable future operations. Landlords without the ability to demonstrate capital resources are at a competitive disadvantage.
- “Zombie” properties, defined as overvalued performing assets which will be difficult to refinance within the immediate and medium-term timeline, haunt lenders and borrowers alike as to exit strategy reversions.
- Net operating income calculations based on adding capital reserves create more debate between buyers and lenders; lender funding availability and underwriting guidelines overrule any such discussions.
- Active bidders include private funds in various formats such as REITs, opportunistic syndicates and wealthy individuals – few public players hunting today.
- Largest transactions are limited to about $75 million per lender, and few deals are “clubbed” as lenders are remain focused on internal portfolio issues.
An advisory board member of the Real Estate Capital Institute, Jim Postweiler, notes that “Smaller properties below $25 million enjoy the most amount of acquisition activity. Larger projects still create issues for attracting optimum leverage and sufficient funding sources.” Postweiler adds, “Foreign investors, mainly from Europe, are reemerging as buyers for prime investments in major CBD markets.”