Chicago, Illinois, July 7, 2010 –As stock markets slide downwards, treasury rates follow suit with five and ten-year yields rounding down about 30 basis points lower from June — below 2% and 3%, respectively.  Combined with dropping spreads, borrowers are now enjoying fixed rates in the 4% to 5% range for lower leveraged loans.  Floating-rate loans stay attractive, sometimes below 4%, as fears of inflation dissipate for the time-being.

 Oversupply of funds being mismatched against a much sought-after supply of higher-quality funding opportunities is the theme for much of 2010. However, this issue is evermore pronounced as lenders are under more pressure to fund such assets. Unlike the past two years, the real estate capital markets are more stable as fresh transactions established new value benchmarks helping to remove valuation uncertainty from the underwriting process.  Look to a flurry of aggressive lending at the end of the summer, when most capital sources realize production levels are inadequate.  

While still trying to maintain underwriting discipline, lenders seek creative funding solutions.  For the most part, lenders continue to impose floors to dampen yield erosion.  The yield dams, however, will break as more monies flood the market.   Expect longer amortization schedules (returning to 30 years), leverage approaching 75% or greater and funding flexibility such as partial fundings and forward-delivery loans.  However, debt service coverage will remain at about 125%, since rates are relatively low.

The Real Estate Capital Institute’s director, Jeanne Peck, expects “Qualified borrowers are fast gaining the upper hand in negotiating debt.  Low rates combined with more attractive leverage translate to fantastic cash flow opportunities.”  Adding, “However, the equity markets see such competitive financing as reasons to maintain solid pricing, as refinancing remains a very real option vs. liquidation.”

Chicago, Illinois, June 7, 2010 –  More positive news on the realty capital front as recovery from the current downturn is recapitalized by funds which were raised prior to commercial mortgage product being more widely available.  Funding demand is readily available for freshly originated capital  underwritten to currently more stringent standards.  In particular, many non-investment grade credit funds desire new commercial mortgage exposure as secondary market spreads have rallied. 

How does revived realty capital market translate to property-level funding kinetics?  

• New Benchmarks – The Debt Yield (in-place NOI divided by total debt) has now emerged as a popular underwriting index.  This index provides a quick gauge of the debt payment cushion, similar to the debt coverage ratio.  For example, 9.5% to 10% was common yield in during the market peak (2007-2008); now the index falls within the 11-12% for most types of permanent loans. 
• Favorite Fives – The number five seems to be the most favorite digit for tweaking deals.  Funding sources use the number five in many different underwriting scenarios including: 5% more leverage (70% vs. 65% LTV), 5% less debt coverage (120% vs. 125%), 5 years more in amortization (25 years vs. 20 years) and 5% more occupancy in improving markets (90% vs. 85%).
• Floors – In select cases, lenders reduce [or even eliminate] floors and rate protection for floating rate loans on shorter-term debt (e.g., 5 years or less).  Rate protection can be waived for lower leverage loans, generally 50% or less.   Simultaneously, rate floors are dropping to 3.5% to 4%, as funding sources favor quality over more realty risk.
• Thinking Outside the Box – New Market Tax Credits, Private Placement Offerings (e.g., CIS-Sanctioned EB-5 Foreign Nationals Program), Recovery Act funds and other non-conventional funding vehicles are gaining attention, especially for new construction projects requiring substantial subsidies and equity capital.  Such funds can be used for more challenging assets including senior housing, retail and mixed-use as well as lodging properties.  Available on a select basis and in very focused areas, these programs are highly technical and therefore require substantial consulting expertise for processing. 

The Real Estate Capital Institute’s advisory board member Aaron Gruen suggests “Many economic indicators are improving or stabilizing indicating the worst of The Great Recession is slowly moving behind us.  However, while the capital markets are showing improvement and signs of increasing stability and recovery, asset-level performance improvement is spotty and inconsistent.  Heightened volatility and uncertainty continues to reign.”  He adds, “Targeted risk analysis is especially important today, given that uncertainty and ongoing shifts in demographics, consumer behavior and variability in economic and fiscal performance between and within regions that can be expected.”

Chicago, Illinois, May 5, 2010 – Capital continues to flooding the markets and few attractive investment opportunities surface.  While many investors see improving conditions for funding, preserving cash flow remains tantamount.  Evolving realty capital market trends include: 

• Capital:  Both debt and equity are both back at levels well above 2009 lows.  Yields are rapidly compressing and good quality projects capture substantial interest with 30 to 50 bidders not being unusual.  Yet, unsecured funding for private developers still somewhat limited, while public funds have ample access.  Projects in second-tier markets, or without cash flow, remain dormant.
• Funding Sources:   Banks will save deals with negative basis, if borrower is a solid and responsive sponsor willing to commit some level of additional liquidity.  Otherwise, land and other non-cash flowing assets will be liquidated over the next few quarters.  Also, newly recapitalized banks [no legacy issues] are starting to advertise debt for income properties.  Meanwhile, life companies increase leverage to 70% or more and multiple CMBS players are back in action. 
• Fresh Faces:  Foreign buyers, including Canadian, Asian and European buyers are bargain-hunting for properties as well as financial institutions.
• Yields: Lowest rates hover in the mid-5% range for long term debt; 4.5% for short-term.  Core investments attract unleveraged returns in the higher-single range, while more entrepreneurial investors are trying for 15% returns, but finding very limited buys in a crowded buyer universe.  Buying mortgage notes emerges as a popular platform for distressed deals with higher yields, but many shy away from risks associated with potential title issues and prolonged court battles.
• New construction:  Need public backing for generating substantial equity.  Also, institutional and multifamily uses are justifiable – retail, office and industrial only on a very selective basis.  Ed[ucation], Fed and Med[ical] are the most attractive realty opportunities.  Also,  many believe it’s the right time to look for entitled urban land as infill remains hard to find.
• Protecting Cash Flow:  Tenants are very price sensitive and will sacrifice quality for substantial rent discounts.  In fact, in many markets commercial-property values declined to levels not seen in nearly two decades.

 Jeanne Peck, the Real Estate Capital Institute’s director, cites “Like Humpty Dumpy, investors sit on piles of cash.  These investors will either find profitable opportunities, or, cushion any financials falls by paying down debt on existing holdings.”

Chicago, Illinois, April 1, 2010 – Realty capital markets continue on a slippery path of gradual recovery held up by the Fed’s desire to keep benchmark rates unchanged – a policy upheld since December, 2008.  Yet bond investors are nervous and driving up spreads as fed notes and bonds start to saturate debt markets and ultimately trending towards higher rates.  In the past month, treasury notes rate ranges climbed by 25 to 40 basis points, with shorter-term maturities showing the most movement. 

Ultimately, this trend leads to higher borrowing costs, but pressure to invest is driving down spreads over treasuries.  Bank cost-of-funds are still at record-low levels, but legacy deals and loan workouts take front stage.  Therefore, new construction and higher-leverage funding are still problematic for short-term fundings.

As for longer-term permanent loans, life companies, select CMBS lenders and pension funds are selectively returning to the realty capital markets, but in incremental steps.  Agency lenders remain firmly committed to multifamily lending about 85% market share.  Loan underwriting “tweaks” are now the norm as these lenders want to differentiate themselves in capturing funding opportunities from a limited pool of qualified projects.  Tweaks include:

• Typical bank deals are structured with very attractive spreads over LIBOR (e.g., 350 bps).  However, floors are formulated on the base calculation (LIBOR floor of 1.5%), effectively raising the rate to a base of 5%, for instance.  These floors are starting to be lowered as banks compete more.
• Mezzanine loans are now bundled with agency debt with leverage in excess of 80% becoming commonplace for higher-quality multifamily loans.
• Loans that are 100% or more above value are known as “pretend and extend” situations where lenders are losing hope of full principal recovery.  If more equity is contributed, bringing the leverage levels to 80 to 100%, financial institutions will usually cooperate with loan modification actions.
• Full leverage of as much as 75% of value is offered at premiums of 50 basis points or more in rate.  While the premium is still costly, this tweak signals lenders’ willingness to raise the leverage bar based on current values.

The Real Estate Capital Institute’s Advisory Board member, Gary Duff, notes “In a sign of renewed optimism, Wall Street reenters the markets in its more traditional role of funding large and highly structured transactions, as well as ventures with debt/equity components.”  Duff suggests “Normalcy is returning at levels comparable to the late 1990’s.”

Chicago, Illinois, March 2, 2010 – A painfully slow rebound ignites mild excitement in select sectors of the income-property realty markets.  Sparks of hope kindle the industrial and housing sectors as most investors sense the bottom is near, or within the near horizon.  Choice retail properties also suggest a recovery as consumers cautiously return to stores.  Office and lodging assets are bombarded with oversupply linked to shrinking demand, corporate cost-cutting and rising operating costs.

Rising defaults plaque legacy mortgage portfolios and many lenders still choice to stay on the sidelines to workout their portfolios.  Banks are starting to liquidate non-performing assets.  The Agencies are tightening underwriting standards across the board using more conservative income and expenses, lower leverage, high debt service coverage.  Yet hope springs eternal.

Recovering from near-collapse within the past 18 months, the capital markets are ahead of overall real estate fundamentals.  The most important concern?  More money than funding opportunities.  Will the markets return to more liberal conditions?  Probably not very soon, but some positive signs surface: 

• Steady fiscal policy, repayment of government bailout monies, GDP growth, reduced job losses and recovering manufacturing contribute to growing optimism.
• Overall mortgage-rate ranges start just below 180 basis points, starting to approach historical norms.
• Tightening spreads between conventional funding sources and agencies – now about 25 to 75 basis points for select apartment fundings, for instance.
• Overall interest rates and benchmark indices holding steady despite improving economic conditions and fear of inflation as noted by a mild reaction to the Fed’s increase of the emergency lending rates late last month.
• Bidding is very brisk for prime multifamily and credit-deals.  Cap rates are clearly narrowing for “best in class” projects which should bode well for lesser-quality assets as investors move down the food chain.
• More lenders returning to the market including life companies, banks and even CMBS players.  The level of interest is conservatively more than double seen in the past year.
• Agencies and other select sources introducing mezzanine and more structured financing as part of the capital stack – the beginning signs of improving funding terms based on higher leverage.

Jeanne Peck, of The Real Estate Capital Institute’s Advisory Board, states “Denial is now being replaced with Decision.  Legacy funding sources and owners are starting to either restructure with fresh equity or liquidate.   2010 looks more like a year of action.”  She predicts, “We should have a very good feel of momentum by mid-year.”

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.

Modest job growth combined with controlled government spending discussions directly affect the current economic recovery, which is slowly trickling into the real estate capital markets. Policymakers are also helping by holding interest rates low at levels favorable for real estate markets. Funding activity is scant, but signs of new hope are emerging. During the month, some lenders slightly dropped mortgage spreads by at 10 to 25 basis points. Short-term loans remain relatively unchanged, while permanent loans now start at about 5.5% for multifamily assets and 6% for commercial properties.

As lenders workout of their legacy problems, new funding goals surface which are moderately more ambitious than 2009. 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. Since rates remain low and funds are scarce, lenders resort to more creative solutions to capture such limited opportunities, including offering mezz debt and applying net worth covenants.

A renewed interest is arising in mezzanine programs, particularly for multifamily fundings. On a selective basis, funding sources can dip below the standard 125%-debt-service-coverage threshold for loans already on the lender’s balance sheet. Payment formats based on self-liquidating amortization schedules of 5 to 10 years and a maximum leverage is 80%.

Net worth covenants are required on a selective basis to help protect lenders against problems associated with sponsorship vs. the actual asset. For instance, the sponsorship should maintain a minimum net worth equal to the loan amount of which 10% or more is liquid. Noncompliance results in a loan default which is curable by principal paydown or additional credit support (e.g. letter of credit). This structure is more difficult to enforce for partnerships with different principals, as well as larger institutional-grade transactions.

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Chicago, Illinois, January 11, 2010 – The start of a new decade adds fresh hopes and fears in the realty capital markets.  The Fed’s persistence in supporting lower rates is helping to avert more financial suffering from increased cost of capital.  Investors are encouraged to gravitate from low-yielding governmental debt.  Dual-personality investing prevails as many of these same investors seek relief on legacy assets, while trolling for fresh new assets based on more attractively reset prices. 

How are capital markets positioned for this new decade and what are the key trends starting off the year? 

• Oversubscribed Monies:    More funds exist than placement opportunities.  Buyers expect lower prices and sellers don’t want to realize heavy losses unless under duress.  During the past year public funds (mainly REITs) raised more than twenty-five billion dollars of equity for income properties funds.
• Redefined Pricing Expectations:  Sellers are reluctant to unload legacy assets at deep discounts, contrary to market logic given today’s stagnant economy.  Investors targeting performing assets for traditional property types remain disappointed in trying to acquire seemingly distressed, value-add and Core-plus deals.  Overall returns of 20% or more targeting shorter holding periods are sparse in major markets.  Such investors will need to expand risk horizons and lower return expectations to include longer holding periods, more diverse property types and non-gateway markets. 
• Replacement Cost Metrics:   Investors willing to forgo immediate returns rise as winning bidders.  Mostly private and overseas funds, these players understand values based on replacement costs, as well as currency plays.  Overall returns are ignored, instead focusing on extremely low costs per unit, assuring limited probabilities of competition from new construction over the long term.
• Rising Liquidity:   Last year numerous major investors reported plunging transaction volume levels of as much as 90%.  As 2009, will be remembered for limited activities in the capital markets, this year should see more deals as financial institutions liquidate sub-performing assets.  However a dearth of activity is not expected; rather a modest pace at first.
• Looming Loan Maturities:  As much as a half-trillion dollar of debt will mature this year with limited prospects of refinancing other than the current funding sources, in most cases.  Furthermore, 2011-12 maturities are at similar levels.  Many believe further government intervention will continue as few economically justifiable “rescue capital” solutions surface.

The Institute’s Advisory Board Member, John Oharenko believes, “We’re bouncing along the market bottom as values continue to slide, but a less dramatic levels.”  He suggests, “Some of the greatest investment opportunities lie ahead, especially for those buyers willing to sacrifice current return and relying upon overall market momentum to improve during the next three to five years.”

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