Investment Watch: Is It Getting Late?

According to Ryan Malatesta at Calmwater Capital, robust capital markets, low interest rates and other factors have boosted numbers to pre-recession figures and beyond. However, many industry players are starting to wonder if the cycle is coming to a close.

As we enter the second half of 2017, there is resounding sentiment among all real estate investors: “it’s getting late in the cycle.” It is clear the commercial real estate industry runs in cycles, and many investors believe the current cycle has gone on far longer than originally predicted. Despite the fact that the U.S. economy remains strong, there are new signs of softening among certain real estate asset classes and markets. Will there be continued rent growth and relatively low vacancies? Has the market reached its peak? Will fundamentals level off and plateau? Will there be a correction and potential decline in values? Time will tell, but the recurring theme is that today’s market is at or near the end of this current cycle.

Commercial real estate professionals have been worried about an eventual regression for years now. Nevertheless, fundamentals have continued in a positive trajectory, capital markets have been robust, interest rates have remained relatively low and cap rates have continued to decline. All of these factors have pumped values to pre-recession numbers and beyond. The change in political parties and uncertainty of the new agenda caused many equity investors to take a “wait and see” approach at the start of this year. This has continued throughout the year, as there is still a measure of political uncertainty which has resulted in an overall drop in investment sales transaction volume in 2017 when compared to the last few years.

HVCRE, Dodd-Frank risk retention and other regulations on middle market lending have made it more challenging to borrow at leverage levels seen in previous cycles. This has been especially prevalent over the past year, with banks becoming more and more conservative. The tightening of capital has provided challenges to middle market investors who may not be capitalized with public capital or institutional fund managers sitting on billions of dollars in dry powder. However, the more stringent underwriting has kept the overall commercial real estate market in check and the overall lending community in good health.

As a result of increased regulation and lower leverage availability from traditional capital sources, the current environment has provided an opportunity for non-bank private lenders to fill the void, specifically in the small and middle market space. Calmwater Capital alone has provided $1.7 billion in middle market bridge loan financing since 2010. In that space, we have seen a significant increase in non-bank private capital entering the market over the last couple of years. This increase in available capital is healthy for the market, but it is important that investors enter into borrowing relationships with lenders who have established track records, are disciplined in their underwriting, are backed by strong and diversified capital sources and plan to stay in the market beyond this “situational opportunity” – all of which Calmwater prides itself on. We will have to see how things play out and if the new administration follows through with loosening these regulations. If so, many of these newly formed private lenders may not be able to sustain.

While the increase in regulations may have been painful for many of the traditional sources of capital, it has restored confidence and stability in the commercial real estate sector. Even in the event of a correction, we do not anticipate an all-out freeze in the debt markets like we saw during the Great Recession. With that said, we expect the lending environment to remain relatively conservative – but remain open for business. At Calmwater Capital, we plan to continue to grow our lending activity by being a trusted source of non-bank bridge loan capital that provides certainty of execution, flexibility and speed to borrowers nationwide – and we plan on staying around for the long haul.