2017 Capital Markets Year in Review
- Dec 20, 2017
As the year comes to a close, we reflect on the major trends in the real estate capital markets and their impact on operating, investing and new development activity nationwide.
The capital markets continue to push forward with a full head of steam through year-end. Today there is ample liquidity and reliable competition among lenders at all levels of the capital stack. Geo-political concerns that dominated the first quarter of the year have abated, as the national economy continued to expand at a steady, manageable pace. As a result, this year we saw lenders enter new markets, expand their platforms to lend on niche product types, and take on more execution risk in order to maintain pricing and constrain LTV/LTC ratios.
On the institutional equity side, 2017 proved to be a challenging year to deploy capital, as liquidity compressed yields across the risk spectrum, new supply (especially in multifamily) tapered rent growth in most major markets, and concern over the longevity of the real estate cycle tapered equity investor appetite for investments that were exposed to significant market risks beyond two years from the initial investment date. On the international front, we saw the Chinese government curtail outflow of capital from China, which resulted in a palatable contraction of new Chinese equity capital in the market. On the other hand, we saw Japanese investors expanding their U.S. investment focus in a significant way.
- Construction Lending: New banks sparingly entered the constructing lending market in 2017. The few that did created lending programs that took advantage of the pricing gap between their bank peer group and the pricey, non-recourse, debt fund construction loan options. In general, construction financing in 2017 seemed to find a comfortable equilibrium between demand from the development community and supply from bank and non-bank lending sources.
- Multifamily: Competition among lenders on stabilized apartments (or new projects in lease-up) continues to be ferocious—with loan proposals sized and priced to perfection in coastal locations. Borrowers are being fully enabled on their refinances, as underwriting standards reflect current valuations, despite the expectation that interest rates will move.
Additionally, mobile home communities seem to be in favor with lenders nationally. The expectation is that the agencies will continue to provide strong tailwinds, with 2018 multifamily lending caps for Fannie Mae and Freddie Mac projected to be at $35 billion for each enterprise, just slightly down from $36.5 billion in 2017.
Agencies (and some banks offering fixed-rate programs) are proposing increasingly attractive terms, in contrast to conduit lenders (further discussed below) who are restrained due to risk retention and consistent discipline from the CMBS B-piece buyers.
- Office / Industrial: Industrial properties and creative offices have grown as a result of technological disruption, fundamental change in consumer habits, as well as the desire to attract and retain millennial talent.
Institutional equity funds continue to express a strong appetite for both value-add and ground-up development opportunities in the industrial sector. Generally, industrial is wholly accepted and recognized as a critical component of a commercial real estate portfolio allocation. Equity investors and lenders understand the need to be involved on speculative, ground-up industrial deals in order to win business, as demand drivers show the strength of the containerized supply chain going forward.
The appetite for creative office remains strong, although with time horizon constraints due to the expectation of economic slowdown at some point in the next two to three years, investors in value-add projects are leaning heavily toward business plans that can be executed within 24 months. Longer business plans are being hyper-analyzed due to the expectation of a general slowdown in the economy thereafter.
- Retail: Today, retail is all about buzzwords: “right sizing the retail experience,” “experiential,” and “omni-channel” concepts are popping up in our conversations with sponsors. The retail space is evolving, sparking curiosity in equity investors and caution from lenders. We are seeing valuations shift to indicate that equity can mitigate the sector risk in retail with smaller bets in this space.
Meanwhile, the commoditized grocery or big-box, anchored business plans based on population density and demographics are considered non-starters for most equity investors unless there is a compelling story (or basis).
- Land: Lending on land is all about location. In-fill sites are receiving multiple bids from lenders for pre-development bridge loans that range from 12 to 24 months. Lenders are most aggressive on residential for-sale and multifamily sites.
- CMBS: Updated risk-retention regulations have created higher barriers to entry, with minimal movement in who the main players are in the CMBS peer group. Pricing has remained steady in the past year, providing lenders with some respite after market fluctuations around year-end last year left some borrowers with rates above their original quotes. Going forward, our sense is that it is a game of scale—larger players are taking more market share.
A few new, non-securitized lenders have entered the fixed-rate space, looking to pick off the small dollar loan requests by offering fixed transaction costs and in-house servicing.
Overall, our recent conversations with players in the equity, debt and brokerage space have a familiar theme: everyone seems to have had a busy and productive year and is looking to take a few weeks off at year end to recharge for a competitive year ahead in 2018.