Real Estate Capital Scoreboard® – December, 2019

Chicago, Illinois, December 1, 2019 – Realty capital markets remain steady, as the five- and ten-year treasuries moved about 20 basis points upward during November, settling under five basis points higher than the end of October. With such low rates, few borrowers complain about actual rates. Instead, the short supply of deals that pencil-out seems to be the “hot topic” as 2020 approaches, creating the following talking points:

Patient Capital: In recent months, the sharp decline in sales volumes on a nationwide basis is not a result of a shortage of capital. Investors under no pressure to fund deals patiently sit on the sidelines. Only time will tell if such a wait-and-see strategy yields more attractive deals in the future or missed opportunities. Ultimately, building liquidity may be a great strategy if the economy and related realty investments succumb to recessionary levels. Otherwise, more difficulties on the horizon for trying to deploy capital in an oversupplied marketplace, as prices remain at historically high levels. For example, capitalization rates and longer term mortgage pricing is 150 basis points or less differential, leaving minimum room for yield upside – at least 50 basis points tighter than the historical norm.

Rate Structure: The narrow difference between longer term fixed-rate and floating-rate debt firmly redirects property owners to focus on holding strategy timelines and less so on pricing dynamics. Prepayment flexibility moves up much higher as a negotiating point on making rate structure decisions, including types of lenders (e.g., banks vs. mortgage conduits). For example, securitized debt instruments allow more extensive variation in loan language for permitting issuers to modify some borrower changes in terms and conditions.

Loan Proceeds: Over the past few years, the 65% loan-to-value ratio evolved to be a commonplace benchmark for maximum senior debt proceeds, especially with life companies and other institutional lenders. Funding sources continue maintaining underwriting discipline by adhering to minimum debt service coverage ratios of at least 125% and sizing loans to support stress-test rates of five to six percent. However, debt funds, conduits, and even banks step up to higher loan proceeds of as much as 75%, without adding mezzanine or other higher-priced secondary debt leverage enhancements. For example, full leverage loans of 75% are priced only about 25 to 50 basis points higher for the additional proceeds – a lower cost alternative to raising equity.

The Real Estate Capital Institute’s founder and executive director, Mr. John Oharenko, advises, “Realty capital markets selectively layer yield and principal risk profiles, mostly based on funding sources. Life companies, banks and other highly regulated funding sources stick to conservative transactions, while debt funds and entrepreneurial players continue seeking greater yields, including new construction and other opportunistic ventures.”

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