The cost of money might not be going up after all. Signals from the Federal Reserve over the last quarter had been pointing to a raise in interest rates in September. But a new jobs report from the US Labor Department showed softer gains than were predicted. Now the signals point again to rates being left at their current low levels.
In the commercial real estate investment world, one of the most important values to compare potential investment properties is the internal rate of return, or IRR. One way to think of this value is a display of the growth rate the project is expected to generate. It’s a number that, roughly speaking, describes profit after cost of capital is paid for. Real estate investment firms put so much stock into IRR that they commonly use it as a major deciding factor to greenlight a project or not. If a project’s IRR doesn’t meet or exceed the firm’s minimum acceptable return, or required rate of return (RRR), chances are that project is a no-go for the firm.
If, during the past twelve months, you’ve gone to the capital markets and suspected that banks aren’t playing ball quite as much as before, a key survey of loan officers says you’d be right.
This week, the Federal Reserve Bank released its Senior Loan Officer Opinion Survey. The project looks at changes to the terms of commercial loans, including loans for commercial real estate. 71 domestic banks and 23 branches of foreign banks were heard from in this year’s survey.
Quarter to quarter, week to week, day to day, the price of capital fluctuates. The changing cost of money has a lot of say in what’s possible for any given commercial real estate development, so getting indebtedness exactly right is an essential, foundational job. Who’s refinancing commercial properties and where? Let’s take a quick look at the recent national scene.
- Meridian Capital Group Secures $4.8MRefi for Mixed-Use Property In L.A. – Drew Anderman and Sean Robertson of Meridian secured the seven-year, fixed-rate loan on behalf of the borrower.
- New Lenders Stepping Up To Refinance Debt – NAREIT podcast talks wave of debt maturities in CRE.
- Highpoint On Columbus Commons in Ohio gets $40M Refinance – 300-unit 7-acre development goes once again to the refi well.
- HFF Secures $9.75MRefi For Redevloped Shopping Center in Metro Atlanta – 100KSF retail center in Roswell goes floating-rate for the new deal.
- Northmarq Capital Secures $14M Refi for Publix at Summerfield Crossings – 10 year loan, 30 year amortization schedule for employee-owned supermarket chain.
- Grandbridge Real Estate Capital closes $67.5M refi for 3 multifamily properties in Dallas covering nearly 1000 units.
- Commercial Lending Conditions Tighten in REALTORS® CRE Markets – Wherein NAR’s own quant research guru George Raitu spells out the shifting picture of the financing market in CRE.
- Meridian Capital Does Manhattan – $160M Refi for 1926 26-story tower at 245 Fifth.
- Brickell City Tower Closes $61 Refi – Iconic 33-story Miami tower rewrites its loan.
- Miami Neighborhood Shopping Center Gets $6.5M Refi Deal – Team worked around an anchor grocery unwilling to commit to longer lease.
Yesterday, the latest edition of the eight-times-annually published Federal Reserve Beige Book arrived (or, as the kids say, dropped). What lies within its muted brown pages and cream-tone cover*? Good news for the state of the commercial real estate industry.
Construction and Real Estate
Construction and real estate activity generally expanded in late February and March, and contacts across Districts maintained a positive outlook for the rest of the year. Residential real estate activity strengthened, on balance, with robust growth in San Francisco, Cleveland, and Boston, but more mixed reports from Dallas, Kansas City, and Atlanta. Several Districts credited a mild winter for stronger home sales, and the pace of home price increases picked up in a number of Districts. Multi-family construction remained strong in most Districts. Chicago, Cleveland, and St. Louis also noted some improvement in demand for single-family home construction, and a contact in San Francisco reported backlogs of more than six months for new single-family units. Commercial real estate activity generally increased, with leasing activity and rents rising in many Districts: particularly strong leasing was noted in retailing in Chicago and in the industrial sector in Dallas. Vacancy rates either moved lower or were unchanged in most Districts. Most Districts reporting on nonresidential construction said that demand increased. Contacts in Boston said the education, health care, hospitality, retail, and office sectors all contributed to its recent construction boom. Nonresidential contractors in Cleveland cited broad-based demand, with particular strength in education and healthcare projects, where several builders expressed concern about their capacity to take on additional projects. In contrast, Chicago noted continued weak demand for industrial construction, and Philadelphia reported fewer starts of new nonresidential projects.
The Federal Reserve Beige Book gathers anecdotal information on current economic conditions in its District through reports from Bank and Branch directors and interviews with key business contacts, economists, market experts, and other sources. The Beige Book summarizes this information by District and sector. An overall summary of the twelve district reports is prepared by a designated Federal Reserve Bank on a rotating basis.
* The Beige Book is not colored beige, nor is it a book.
The Mortgage Bankers Association’s combined national numbers for commercial mortgage debt held by non-banks tell an interesting tale. The total dollar amount of maturities has risen a sharp 51% from 2015, meaning more debt will mature – yet the bottom line is that principal balances are increasingly prepaid and paid-down.
Coming off its second-strongest January ever, the national market in commercial real estate looks as robust and promising as it ever has. But are signs of a downturn hidden in all the good news?
Real Capital Analytics SVP Jim Costello thinks there are. Costello has identified a series of warning signs in the national CRE market that he believes foretell bad news for national commercial property as an engine of profitability. They include:
- Deal volume year-over-year is lower (-7%), despite big gains in the total number of dollars changing hands (+12%). Costello cites the momentum in the lost volume, making it harder to perform the comps that ultimately inform and inspire so many new deals in CRE.
- The transaction types lend to the alarm, according to Costello. He cites a significant 42% of the market was taken up last year with transactions at the “portfolio-level” or “entity level”, where aggregations of properties hit the market together. He cites the sale of individual buildings as the “bedrock” of the CRE market, and points to such a large portion taken up with stratospheric marriages of big capital and big portfolios as a negative for ongoing growth. He further cites that individual building transactions were down 18% from the previous year.
- CCAR testing regulations for banks servicing secondary and tertiary markets made Costello’s list of negative indicators, where capital adequacy testing imposed by Dodd-Frank could add to the worry of creditors contemplating financing of commercial transactions and projects in these smaller markets.
Not a doomsayer roaming the land in sackcloth and ashes, Costello cites the US commercial property market as the fastest growing and most stable in the world and predicts the markets will perform as a “bond equivalent,” attracting capital from around the world seeking safety and performance. But with numbers as high as they are, Costello’s cautious* voice could find validation in a market that shows any signs of getting away from its fundamentals.
*EDITOR’S NOTE: While Jim’s findings do sound a note of worry, calling his perspective “bearish” is overstating it. We’ve changed the description to “cautionary.”
Last week saw the publication of the latest Beige Book, the six-times-annually published economic activity report from the Federal Reserve Bank that looks at the whole country divided by Federal Reserve Districts. You can read the entire Fed Beige Book after the link. Below find the key takeaways for commercial real estate nationally:
Real Estate and Construction (Nationwide)
Most reporting Districts characterized nonresidential real estate activity as modest to moderate; Boston and New York indicated little change. Rental rates rose in more than half of the reporting Districts, and vacancy rates were mixed. Most Districts reported modest or moderate growth in commercial construction, and the Dallas District noted high levels of industrial construction in Dallas-Fort Worth. Contacts in the Atlanta District expect construction activity to increase slightly, while contacts in the Philadelphia, St. Louis, Minneapolis, and Richmond Districts expect overall commercial real estate activity to continue to strengthen at least modestly.
Banking and Finance (Nationwide)
Lending activity appears to have improved on net. Loan demand grew on balance in the Philadelphia, St. Louis, and San Francisco Districts. Cleveland, Richmond, and Kansas City reported stable credit demand, on balance, while Dallas noted some recent softening. Philadelphia reported the strongest loan growth for autos, commercial real estate, and commercial and industrial deals, while residential lending was flat to down.
Banking and Finance (Chicago District)
Financial conditions tightened slightly on balance over the reporting period. Financial market contacts noted greater illiquidity in the bond market. In addition, a contact in commercial real estate financing reported a decline in interest from institutional investors amid concern that the commercial real estate market was overheated.
Construction and Real Estate (Minneapolis District)
Commercial real estate activity was moderate to strong since the last report. Retail, office, and industrial vacancies in Minneapolis-St. Paul have been falling and rents have been rising, according to multiple industry reports. In northwestern Montana, commercial vacancies “have mostly disappeared,” with rates stabilizing at about 5 percent, said a local source, while the Rapid City market “has been extremely active these last couple of weeks of the year.” […]
The cost of money has come up for the first time in more than nine years: the Federal Reserve Bank announced a raise in its short-term interest rate of a quarter point. For a quick look at various takes on the move, check out the following video gallery
In the commercial property finance ecosystem, the cost of money is tied to widely used benchmarks such as the federal funds rate. Ongoing rumblings from watchers of the Fed are that the cost of money — aka the Fed’s funds rate — are soon on their way up for the first time in nine years. Remarks from Fed Chair Janet Yellen leading into he December 15-16 Fed meeting seem to support the idea that a boost in rate is on its way.