DLA Piper Special Report: CMBS Back, REITs Up, Liquidity Plentiful in Capital Markets

Speaking at the DLA Piper 11th Global Real Estate Summit in Chicago yesterday, industry movers and shakers remained only cautiously optimistic about the future of commercial real estate, despite several indicators pointing to a rebirth of the field.
L to R: Randall Row (moderator); David Neithercut, Equity Residential president & CEO; Debra Cafaro, Ventas Inc. chairman & CEO; Mchael Fascitelli, Vornado Realty Trust former president & CEO; Roy March, Eastdil Secured CEO

Speaking at the DLA Piper 11th Global Real Estate Summit in Chicago yesterday, industry movers and shakers remained only cautiously optimistic about the future of commercial real estate, despite several indicators pointing to a rebirth of the field.

“U.S. commercial real estate markets are viewed as stable havens; real estate cap rates will also remain steady,” said Jay Epstien, DLA Piper U.S. Real Estate Practice chair, during the introduction of the conference. “U.S. commercial real estate is on the right track, (but the) question remains, will we not repeat mistakes of the past?”

Several of the panelists speaking at the summit, which one speaker called the “Woodstock of commercial real estate professionals,” commented on the return of commercial mortgage-backed securities showing that commercial real estate lending is back and reflecting good times for borrowers. Even though the CMBS market is nowhere near the $230 billion in sales registered in 2007, it reflects a steady recovery, with $7 billion available in the fourth quarter of 2012. Roy March, CEO of Eastdil Secured, said more than $85 billion is expected, with $30 billion already issued to date, “and this is the bottom line of where loan pricing is today,” he said.

CMBS is seen as a necessity by some. At its prime in 2007, it backed 40 percent of all commercial real estate lending. Nevertheless, some attendees expressed a fear of the return of CMBS, reflecting on the mid-2007 national subprime crisis and subsequent credit squeeze, which shut down the main lending arena for property investment CMBS – sending commercial property prices into a downward tailspin. Still, more loan availability makes CMBS an attractive investment as long as lenders take a serious look at the new rating agency and are willing to do proper due diligence prior to handing over money.

Overall, the real estate debt market is characterized by significant CMBS demand for conduit and single-asset executions, strong demand for life company and bank financing, continuing demand for longer durations (15 to 20 years and more), increasing prepayment flexibility, growing availability of debt for transitional assets, and significant spread tightening.

The current theme in the equity capital markets, according to an Eastdil study March presented during his panel, shows that the market in general continues to be very active and liquid. Cap rates are stable to falling. Pricing has recovered to 2006 levels or higher for most institutional assets. Unique assets continue to draw capital from around the globe. And pricing doesn’t yet fully reflect the strength of the debt markets. The market continues to achieve cash flow, quality and security needs, but it is putting a reasonable spread between trophy and other Class A assets. While there is still a material spread between primary and tertiary markets and assets, the CMBS market is expected to narrow that gap.

Another recurring theme was the strengthening of REITs relative to the private players. REIT balance sheets are the strongest they have ever been, and their cost of capital is at an all-time low. Massive dedicated and non-dedicated inflows and expansion of ETFs are driving markets. And equity issuance volumes have been high, with $130 billion raised since 2009-2010.

“I believe 2013 will also be a record year for equity issuance, at least in the current cycle,” March added.

In addition, IPOs have been successful, especially in off-the-run property types. Merger-and-acquisition activity is likewise expected to grow this year.

In conclusion, debt markets are strong, while CMBS is setting the pace. Public markets continue to increase. CMBS players are financing deals in major markets first but likely to expand into the rest of the top 30 markets, which will create some compression and relative returns. Property pricing does not yet fully reflect strength of the debt markets, particularly pricing in the non-gateway cities. Economically sensitive pricing is improving, according to Eastdil data, but there are still opportunities in “manufacturing to core.” Activity should continue to increase, with 2006/2007 debt maturities that have been extended coming due in 2013/2014. The study did caution against complacency, given how fast rates can change due to continued European challenges, the Middle East turmoil and job growth issues.

“The country is growing—not as fast as we’d like, but we’re better off than other parts of the world,” said David LaRue, president & CEO of Forest City Enterprises, speaking about the risks and rewards of real estate and the public markets. “The U.S. is a great innovator. Uncertainty is holding us back, (but) that will clear eventually.”