Las Vegas, NV – February 6, 2010 – According to industry leaders gathering in Las Vegas this week, debt capital is readily available for 2010.  Optimism is in the air and the mortgage lenders are starting to offer more generous terms and conditions. 

In summary, timing is excellent for select borrowers in securing debt based on the following conditions:  (1) Recovering economy, (2) Ample supply of capital and (3) Limited supply of financeable real estate assets. 

The following highlights summarize the 2010 state of the realty capital markets including an overall outlook and overall funding program offerings: 

Back to Basics:

•  As lenders workout of their legacy problems, new funding goals surface which are clearly more ambitious than 2009.
• Still underwriting of actual numbers w/o projections, yet inflation fears exist.
• Most lenders are Indifferent to spreads, but not competition.
• Valuing real estate properties in a declining market still a challenge.
• More allocation of funds available above target amounts if deal flow is of sufficient quality

Underwriting Dynamics: 

As has been the case last year, high-quality projects in major markets backed by excellent sponsorship and cash flow characteristics are most desired—especially based on low leverage of 65% of value. 

Location/Property Types:

• Major MSAs strongly preferred for optional pricing and leverage.  Otherwise a substantially most costly financing with lower leverage.
• Preferred property types ranked in order:  (1) Multifamily, (2) Credit-Tenant lease of all property types, (3) Industrial, (4) Retail, (5) Office – however medical office ranks equal to Industrial and (5) Lodging.

Pricing (Permanent Fixed-Rate Loan):

• Agency pricing for apartments starts in the low to mid-5% range for 5 year or greater term.
• Life company pricing starts mid-5% to 6% for 5 years or more term mostly targeted for commercial property pricing (agencies are more competitively priced)
• More entrepreneurial funds start at 7% or more targeting secondary markets, smaller fundings, older properties and lodging assets.
• Add a pricing premium of 25 to 50 basis points for loans below $5 million.
• Yield differential disappearing – typical ($5 to $50 million) vs. larger loans.
• Forward funds available up to a year based on 6 o 8 basis points premium per month.

 Leverage:

• Above 65% LTV on a select basis combined with lower spreads.
• Values based on the lower of: (a) purchase price, (b) appraised value or (c) lender imposed capitalization rate.

Las Vegas, NV – February 4, 2010 – As lenders gathered here this week to discuss income-property financing programs, nervous optimism filled the air.   The overall forecast is mildly positive — particularly as compared to 2009.   Funding sources were battling liquidity in 2008; rebuilding balance sheets in 2009; and are now earning profits in 2010 which means mortgage investing is back in vogue again. 

However, lenders fear more uncertainty as the capital markets are imbalanced with relationship to income-property supply & demand fundamentals.  Based on key opinions of various lenders an economic outlook relating to realty capital markets is summarized as follows: 

• Modest job growths combined with controlled government spending discussions directly affect the current economic recovery, slowly trickling into the real estate capital markets.  A 10%+ unemployment rate is still problematic, though.
• Slowly recovering economy due to improved CMBS pricing, housing sales and employment statistics.
• Policymakers are also helping by holding interest rates low at levels favorable for real estate markets.
• Industry leaders are reporting a pickup in capital activity including hiring staff, allocating more funds for advertising/marketing and bidding on more transactions.
• Commercial-property problems loom including hanging vacancy (especially office and retail), less space needs, increased operating costs.
• As lenders workout of their legacy problems, new funding goals surface which are clearly more ambitious than 2009. 
• Life companies under less pressure than banks to liquidate assets, if recovery is on the horizon – longer-term balance sheet hold.
• Still a “buyers market” bias due to flat or declining pricing and lower demand, a worrisome scenario for sizing property values.

In summary, industry experts agree that these and other factors will assure that mortgage capital will be readily available in the foreseeable future.  The realty capital markets should continue on a path of greater liquidity.  Yet the biggest trick will be finding suitable real estate investments as the property markets are recovering slower than the capital markets.

About a year ago, the real estate capital markets turned topsy-turvy.  Investors, lenders and real estate professionals alike panicked.  Debt and equity funds nearly evaporated based on false risk/reward expectations.  Nearly all capital markets reached “pricing nirvana,” leaving no room for error as prices peaked to unchartered levels.  Typical income-property loans often were priced within a percent of treasuries — well beyond any historical underwriting guidelines measuring debt coverage margins, leverage and valuations. 

Today, the opposite is true.  Over-reactive fear governs expectations.   The aftermath of the mortgage-backed securities re-pricing and fresh concerns about financial institutions’ real estate portfolios force investors to the sidelines.  Mortgage markets remain dislocated and more problems appear on the horizon.

Are real estate markets in a continuing downward spiral?  Not exactly, if history is any guide. 

Markets are reaching “correct” levels as measured by the past decade.   Many will argue the past five years’ realty capital market conditions were abnormal.  Investors scrabbled from the “tech wreck” in search of new profit frontiers; Wall Street greeted them offering lucrative yields blessed by the rating agencies.  The model worked as long as values continued climbing. 

The rating agencies claimed the new role as risk arbitrators of real estate capital – an untested valuation model for monitoring rapidly expanding mortgage securities market.  Wall Street became Main Street for policing realty supply-and-demand risk fundamentals as well as the traditional role of providing capital.  The judge and the jury.

By the end of 2006, overall commercial property pricing skyrocketed to unsustainable levels as values increased by as much as 40 to 50%, while rent levels remained flat — or even declined.  Investors justified such economics by accepting lower profit thresholds often based on optimistic cash flow projections.

In contrast, more “correct” market conditions existed during the late 1990s.  Project yields were more evenly matched to interest rate costs.  During this era and for most of the Twentieth Century, investment returns normally required positive leverage based on current cash flows, resulting in positive leverage. 

In conclusion, the correction will continue with prices trending downward until investors start capturing more sensible yields in to project and cash flow fundamentals.  The speculative premium needs to be removed from pricing expectations.  This re-pricing is a healthy side effect of excessive capital market behavior.  Measurable, risk-adjusted cash flow will dominate investor’s return expectations — back to basics!

San Diego, Ca. – February 11, 2009 – Lenders met this week to discuss funding goals and objectives for 2009.   The conference mood was filled with caution and anxiety as the industry craves for market stability in the midst of declining property values.  

Key highlights of changing realty funding dynamics are as follows: 

• Valuation Concerns: By far, the most popular topic of discussion was property values.  Most believe that cap rates will return to higher single-digits — in norm with historical levels.  Institutional-grade assets are valued starting at 7% for multifamily properties and 8% for commercial properties.  Furthermore, lenders require substantial supporting data (recent comps) to justify lower cap rates.  Secondary markets and older properties pricings start at 100 basis points or more with much wider variance.
• Capital Availability/Allocation:  Most financial institutions are playing a defensive role, rather than pursuing aggressive growth and funding strategies.  Shoring-up balance sheets and shedding unwanted loans and other realty assets remain key priorities.  Select sources state that they would like to return to the market by the second quarter and mid-year.  Furthermore, most active lenders are allocating substantial portions of funds for refinance and rollover, rather than new loan origination.  As such, these lenders report lower volume of as much as 50% to 60% or less as compared to 2008 levels.  Loan volume targets are intentionally lower due to market circumstances; many lenders are also allocating substantial funds for refinancing existing loans.
• Relative-Value Pricing:  Attractively priced CMBS debt (Triple-A quality) offers the best investment opportunities for lenders preferring to capture the most favorable yields, rather than new origination funds.  Such yields are in the lower-double-digit range.  As such, mortgage rates are still favorably priced for borrowers — within the range of 6.5% to 8.5% for conventional properties based on 10-year terms.  Agencies and select life companies offer the low end of the range, while the higher-end reflects very large loans and leverage in excess of 65%.   Lenders still prefer to originate new loans to help diversify their investment portfolios.
• Sponsorship Quality:  Key emphasis on sponsorship net worth, local market expertise and existing portfolio performance.  Heavy scrutiny of cash flow performance, portfolio leverage and occupancy levels.  Favorable ratios include a clear credit history, net worth greater than or equal to the loan amount, liquidity of at least 20% and strong “hands on” management. 
• Delinquencies:  For the most part, loan delinquencies and defaults are at controllable levels.  Retail properties pose the most challenges, as numerous merchants are in either bankruptcy or requesting substantial rent discounts.  Co-tenancy issues also raising concerns for further occupancy reductions. 
• Tighter Funding Standards: Most lenders are strictly enforcing shorter amortization schedules and wider debt coverage ratios (e.g., 1.25X and 25-year maximum) to restrict proceeds, rather than relying on loan-to-values restrictions as a primary underwriting variable.  That said, 55% to 65% is the norm for most institutional-quality, non-multifamily loans.  REITs, pension funds and private equity capital players requiring less leverage enjoy excellent rates and terms.  Leverage-oriented investors are forced to stay with bank lines, hoping for more favorable funding conditions.
• Rejected Underwriting:  “Fractured” condos — built as condos and now available for rent – are financeable on a select basis.  “Broken” condos – partially converted and available for rent – are avoided.  Lodging, non-essential retail, land loans (nearly impossible without recourse), overbuilt markets, secondary markets.  Basically any properties that are not currently cash-flowing and with too much “story.”  Also avoided are interest-only, cap rates below 8% (unless multifamily/credit tenant), cash-out on cost (no borrower equity in the deal), leverage much above 65% and pro formas.
• Rate Predictions: Many believe rates will remain somewhat steady for most part of the year.  Opinions vary as for 2010 and beyond, although discussions surfaced about stagflation and inflation fears.
• Maturity Risk:  Agencies and many life companies favor longer-term loans in excess of five years as refinance rollover risks are of concern.  Meanwhile, banks mitigate such risks by relying upon recourse and substantial funding deposits, often in excess of 10% of the loan amount.
• Large Loan Vacuum: $50 million + loan funding sources are limited to about a half dozen major life companies.  Otherwise, lenders must syndicate such loans.  Loans under $10 million still offer numerous options including banks, life companies and private capital. 
• “Floor” Rates Prevail:   While lenders are still quoting fixed-rate loans based on treasury spreads, most loans feature floor-rate minimums.   Naturally, floating-rate loans are still quoted floating over Libor, Prime, etc – floors are also imposed on such funding structures.

 General Observations: 

Similar to a decade ago, life companies, pension funds and select banks dominate the permanent funding arena.  Agencies remain the lifeline of multifamily lending.  Banks are most actively funding short-term loans of five years or less.  Life companies control longer-term funds. 

On the other hand, securitization firms continue laying off staff, with the exception of critical support personnel.  Credit companies are also on the sidelines as redevelopment and new construction financing risks remain high based on depressed pricing of existing inventory.

Investors are looking for clues as to how long the gridlock will last.   In other words, when will real estate capital markets return to a “normal” cycle?

According to discussions with advisory board members of the Real Estate Capital Institute, the general consensus regarding the overall direction of today’s realty capital cycle is outlined as follows:

• The Peak:  The overall upward trend started in about 2004 and rapidly accelerated in 2005-06.  The real estate capital markets peaked by the end of 2006 and early 2007. 
• Current Cycle:  Since interest rates and corresponding mortgage spreads continue rising, rate relief is not in site until domestic markets find more stability within the bond markets, in particular.  The remainder of 2008 will be highly tumultuous as investors try to sort of the Wall Street Bailout and access “real” property value.
• The Bottom:  Many believe that the current market doldrums are at least one to two more years in the making with 2009 being a flat, or declining year.
• The Future:  Values will settle to more “normal” levels by about 2011.  Market volatility remains a key concern, but supply and demand dynamics for most types of commercial properties are within general balance.  Longer recoveries are expected in some of the costal markets which were severely overvalued.

Given this two-to-three-year outlook, the new real estate cycle slogan might sound like “Tow the line in 2009; If not then, try 2010.”  

Regardless of exactly how long the current malaise continues, everyone agrees the realty capital markets are in for a wild ride the next few years.

People have more questions than answers including the following:

• How long will the housing crisis last?
• How much leverage is acceptable
• Will securitized mortgage markets return?

Regardless of these questions and many other concerns facing the industry, bricks-and-mortar are physically and economically here to stay. Food and shelter are basic necessities with the real estate industry providing shelter for businesses, manufacturing and housing for the general population. Fundamentally real estate is a sound investment and will rebound in tandem with many other sectors of the economy.

The cause for panic is not necessary as repricing to more historically “reasonable” levels sets the stage for tremendous investment opportunities for investors knowing how to use limited leverage and assuming acceptable risks with the following trends emerging relating to yields and pricing:

• Capitalization rates rising by 100 to 150 basis points over from a year ago, translating to a pricing corrections of 10% to nearly 25% or more, depending upon specific submarkets and property types.
• Leverage levels will remain at 65% for permanent debt until lenders see more stability in the equity markets.
• Return-on-cost metrics demonstrate that investors need to see premiums of 150 basis points or more for new developments over and above existing capitalization rates because of attractive alternative investments. Return-on-cost will creep into double digits figures on a more regular basis, as a result.
• Overall “baseline yields” using relative value mortgage bonds are hovering above 7%, indicating a new floor for profitable lending.
• Equity yields for opportunistic properties will need to reflect 20% or more for short-term investments as substantially more attractive investment opportunities abound in the stock market.
• New-construction opportunities limited to all but the most carefully chosen and risk-free projects such as GSA built office buildings, for instance.
• Project downsizing and repositioning continues as condominium projects are reconverted to rentals.  Vacant office buildings as well as retail facilities are in some cases changing to alternative uses such as industrial and multifamily projects.
• “Hesitation investing” prevails as buyers use time as an effective negotiating weapon for catching better terms and conditions.

In conclusion, whether or not the markets have been re-priced to reflect current realities, opportunities should continue emerging as many investors look to liquefy their portfolios to maintain defensive ownership strategies in light of a cash-strapped economy.

Chicago, Illinois, November 20, 2008 – In today’s extremely difficult funding environment, financing even the most straightforward types of commercial real estate projects proves to be tricky.  In fact, commercial mortgage originations are nearly at a stand-still as lenders attempt to sort out financing dynamics in such an uncertain funding environment.

Of all realty asset classes seeking financing, land loans are the most difficult to entertain.  Any mention of land loans is the equivalent of discussing financial toxic waste.  The current lending and regulatory environment demands any real estate collateral by secured with proven cash flow and limited leverage – neither work well with land loans.  Under such conditions, land loans are limited to high-risk funding sources demanding extremely pricing premiums. 

The highest rewards (and risk) are available in the land acquisition and development arena.  For the most part, land is burdened with carry costs and seldom has any income.  Future use, including economic feasibility and zoning are yet to be identified.  Also, land is immediately impacted by economic cycles.

Land development and entitlement are exclusively focused on the preparation of site preparation for further development.  Locational, physical, legal, and financial elements are interwoven including typography, environmental standards, change of use (zoning) and community concerns.

Most successful land development models are based on “wholesale” land acquisitions (unentitled, raw land) and “retail” dispositions to users, developers and investors. 

Typical formula or land development is based on purchasing an option for the land, the most profitable method.  The option money is used to explore various zoning and physical issues with the site.  Should the process successful, the developer can then use the remaining part of the option to purchase the land.  Alternatively, if the option is not available because of the land value, a developer needs to prequalify much of the main risk issues including zoning, entitlement, demographic: analysis and physical features such as environmental issues.

Under all of these scenarios, local presence in the market is crucial for success.  Some land deals may take three to five years before any results are shown.  Hence, many national firms use local development expertise to assemble and entitlement.

 Unanticipated problems (e.g., extremely costly environmental cleanup), unrecoverable expenses, cost overruns, illiquidity, lost time,  and damaged relationships with governmental local authorities/community groups are among the numerous issues influencing development yield profiles.  As a result, land development ventures often require overall returns of 25% or more.  Even at such yields, changing market conditions such as the current credit crunch and supply-and-demand dynamics make for highly elusive profits.

 While land investing is extremely challenging, financing is still available even in today’s restrictive lending environment.  In order of importance, current funding parameters are as follows: 

1. Prime sponsorship required with proven track record strong financial statement well in substantially in excess of land value.
2. Full Recourse required and additional collateral often necessary, including projects with current cash flow stream.
3. Well below fifty percent or less of value based on recent valuations adjusted for currently depressed market conditions [e.g., 50% to 80% discount typical based on values of peak market cycle 2005-2007].  Lend in infill locations strongly preferred.
4. Pricing reflects significant premiums as compared to any other real estate asset class.  Terms are similar to other business-lending parameters such as line-of-credit fundings.

According to the Real Estate Capital Institute’s Research Director, Nat Zvislo, “Land and development loans present the most challenging fundings.  However if conservatively underwritten, lenders see such loans as excellent opportunities for maintaining and building new client relationships during such difficult times.”

ABOUT US:

The Real Estate Capital Institute is a research organization staffed by industry volunteers who collect and track debt/equity rate data.  The Institute’s website provides daily and historical rates including treasuries and short-term rates.  The Real Estate Capital RateLine (773-227-4825) announces hourly rate updates throughout each business day.

Chicago, Illinois, November 12, 2008 – The old cliché – “Cash Is King” is as true now as ever given the sparse availability of leverage.  Nearly all real estate financings, both acquisition and refinancing, are restricted to funding projects with existing, in-place cash flow.  Cash-flow projections, projects with value calculations based on appreciation (e.g., land) and other ventures lacking sufficient current income ventures are shunned.  Lending is severely restricted as the Real Estate Capital Institute® estimates over 80% of conventional funding sources are temporarily out of the market.

What should be expected when seeking financing today in such a constricted lending atmosphere?

• Cash Flow:  All in all, expect more conservative underwriting across the board when reviewing revenue streams.  In addition to underwriting actual cash flow, lenders are providing further safety nets by including conservative occupancy calculations (using the lower of actual or market vacancy), higher management fees to reflect more hands-on operations, larger operating reserves and richer expenses including escalating property taxes and utilities costs.

• Sponsorship:  More important then in any recent years, sponsorship financial net worth, experience and liquidity are tantamount. Even with nonrecourse loans, lenders need to be assured that borrowers have the ability to maintain projects running into operational difficulties.  Borrower net worth should approximate loan amount and liquidity levels of about 25% are typical.

• Loan Terms:  Lenders are competitive on rate, rather than leverage or other underwriting variables such as interest-only payments, property types or Earnout formulas. Only standard, income-producing properties such as apartments, shopping centers, office buildings and industrial properties are desirable as lenders have limited appetite for real estate debt in general.  Expect 65% loan-to-value for all properties except apartments, which can reach closer to 75%.  Overall rates are hovering in the 6% to 7.5%, including fixed and floating.

The bottom line?

As the markets remain constrained in the foreseeable future, lenders active in the market are extremely selective.  Borrowers must prove themselves creditworthy, both at the project and sponsorship levels.  As such, loan deliverability is the most important variable in today’s real estate capital environment.

Chicago, Illinois, October 22, 2008 — The start of the mortgage meltdown over a year ago continues wrecking havoc on the real estate capital markets.  In particular, accurate property valuation is nearly impossible as buyers and sellers are sidelined due to limited debt availability. 

Few properties are trading hands.  Most investors believe values are trending downward in response to economic malaise, oversupply and lack of affordable debt.  As such, experts are using higher cap rates for valuating assets for most types of commercial and income properties.  Lenders, in particular, are “creating” values by underwriting capitalization rates which may, or may not, reflect current market prices.  These cap rates are typically higher than many sellers are buyers expect, resulting in lower loan proceeds based on loan-to-value restrictions.  Yet, owners often refuse to sell or acknowledge asset values based on lenders’ higher cap rates, choosing to do nothing, instead.

In this stalemate, who’s right and where are cap rates heading? 

An amusing theory discussed by some experts as a humorous factoid suggests that current capitalization rates are directly correlated to the recent year numerical identity as indexed to the current real estate capital boom/bust cycle. Today’s market cycle peaked in 2007, with 2005 and 2006 ranking as the best years for very attractive valuations; in other words, low capitalization rates.

As for 2008, an 8% capitalization rate is the “strike price” for sellers motivated to liquidate properties.  While the markets are illiquid and few transactions leave any proof of value, an 8% capitalization rate reflects a weighted-average premium tied to the cost of capital for most types of income properties.  Applying the same logic in a downward market, 2009 should yield a 9% rate and a 10% cap rate would prevail in 2010.

Linking cap rates to year numerology is certainly an unrealistic discussion for measuring values in the currently volatile market.  Yet as investors search for answers in such uncertain times, numerology adds more theories to an already confusing time.

Chicago, Illinois, October 8, 2008 – Swooning financial markets continue dislodging all sectors of real estate capital with a vengeance.  Funding sources retreat from income-property lending on a daily basis because of liquidity concerns, profitability, overexposure and a host of other factors plaguing this sector.  No conventional lenders are immune including banks, life insurance companies, savings institutions and private funding sources.

Yet a few bright stars shine in the otherwise pitch-dark capital markets.  These stars are lenders with funding goals and objectives that are not exclusively driven by profits.  The Real Estate Capital Institute identifies this group of funding sources as “Mission Money” who provide “Policy Proceeds.”  The four highlights of Mission Money are as follows:

1.    Purpose:  Mission fund objectives vary focusing on public policy (e.g., affordable housing, urban renewal), labor creation, specific geographic investing and property types to name a few.  Typical examples include generating jobs through union labor funds, constructing affordable apartments and reinvigorating economically deprived commercial areas.  Often times, many of these objectives are bundled – e.g., affordable housing with union labor in redeveloping urban “infill” areas endowed with heavy tax incentives.

2.    Property Types: Unlike pure non-profit funding sources, Mission Money exclusively targets income properties, namely commercial and multifamily properties. 

3.    Policy Proceeds:  Direct funding structures include construction, interim and permanent loans as well as equity contributions.  Popular indirect fundings include tax credits, tax breaks and rebates.

4.    Sources:  The lending arena includes federal governmental agencies (e.g. Freddie Mac, Fannie Mae, FHA and the Treasury) and local municipalities (tax increment districts), endowments, pension funds, life companies and private capital providing funds directly (construction and permanent funds) and indirectly (tax credits). 

According to John Oharenko, an industry veteran who serves on the advisory board of The Real Estate Capital Institute®, “In 2009 and 2010, Mission Funds will play an even more important role in supporting real estate capital markets as many conventional funds stay sidelined.”  He adds, ” Even as conventional markets recover, Mission Money will remain a reliable source of funds for developers, investors and others willing to learn about and implement these targeted programs.”