Q&A with The Counselors of Real Estate
- Feb 26, 2014
Mike Ratliff, Senior Associate Editor
We were lucky enough to land a private panel discussion with three distinguished members of The Counselors of Real Estate while reporting the Law & Policy update in our March 2014 issue. The conversation covered a range of topics from the capital markets, asset class and market trends, and of course policy and regulatory matters.
Here we present some of the most interesting points made by K.C. Conway, chief economist, Colliers International; Thomas Fink, senior vice president, managing director, Trepp L.L.C.; and William (Ted) Anglyn, president, Anglyn Property Advisors.
CPE: What are your general thoughts on the health of the capital markets in 2014?
Conway: I think the economy is dealing with a lot of uncertainty. We really can’t seem to get firm traction around the issues from a long-term perspective. The market has become somewhat conditioned to that, but I think the one heavy weight that we might get to in all these questions is the uncertainty about debt costs, and debt capital in 2014.
This year and the next are going to be pretty critical years in the real estate industry, and we are going to need a lot of debt capital to refinance what is coming in the CMBS world and the other property types.
Fink: The capital markets folks in the CMBS space are very optimistic that this is going to be a good year. We think it should be at least as strong as 2013. We actually saw the restart of the global CMBS market, and a stronger performance in Europe. Generally speaking, everyone is optimistic that real estate fundamentals are going to be good in 2014 and 2015. Active lenders have a lot of capital available to lend. I think the availability of debt is not going to be an issue. I think the pricing of debt, as K.C. alluded to, is going to be the question.
One of the things I don’t think you are going to see with interest rates going back up is the kind of refinance balloon risk that we have seen in past periods of rising rates. At least not initially. The reason I say that is that if you look at the way loans have been underwritten for the last several years, everybody has migrated away from looking at debt service coverage ratios and loan-to-values. Today, everybody is focused on debt yield.
Anglyn: I can tell you that Tom is right, there is a tremendous amount of debt availability. As much as 2007 when I was making loans with a life company out of New York. But I know that banks are concerned about how they competitively price their products, as they try to ramp up for hopefully construction lending, which has been somewhat tepid during the last several years.
CPE: Aside from the bond buyback program, what are some issues to keep and eye on with the Fed and interest rates this year?
Conway: One thing that is in play is that stress tests the banks underwent, especially on the commercial real estate side. A year ago, they had the instruction to stretch the real estate to have a 21 percent decline in value and see what that would do to their capital. So a couple of banks passed the test for 2013. The instruction for the current round of stress tests that will probably be released in March is for the banks to assume a 35 percent decline in commercial real estate. That is a much bigger hit on commercial real estate. I thought that was a little premature, and little too aggressive. It is going to be more punitive outside of the core markets because many of these secondary markets have had the property increases you see in New York, San Francisco, Boston, Southern California and Seattle.
Fink: With regard to the 35 percent instruction on commercial real estate, that really says that we are assuming property values return to 2008 and 2009 levels. In the markets where those values haven’t recovered, K.C. is right, we are taking another haircut of 30 to 35 percent below what is already a potentially distressed value. The good news is that the conduits are starting to tread lightly back into those markets.
Anglyn: I would what to emphasize one other aspect. In the last three to four years, you have seen significant increases in underwriting requirements by financial institutions. They have been much more cautious about rollover exposure. Much more cautious than loan-to-value. As capital availability has become more prevalent, we have seen some high loan-to-value figures than in 2010 and 2011 when lenders were far more cautious. I tend to work in the secondary and tertiary markets. I will tell you that financing is not readily available for a lot of the Class B and Class C properties today. That is an ongoing concern.
CPE: What are your thoughts on GSE reform and the appointment of Mel Watt as the head of the FHFA?
Fink: I think people saying that Mel Watt is an enigma is actually a statement that he needs to get his arms around what those two agencies are there for, and how they fit within the capital markets framework…I think the fact that Freddie and Fannie have helped foster documentation standards, and have helped promote standards that have allowed for a much broader electronic exchange of information has been really good. But you have to ask yourself, does it make sense for the federal government to be providing eight or nine out of every 10 mortgage loans in the country as a guarantee? Does it really need to do that, as a matter of public policy and a matter of good sound economics? I think those are the questions that Mr. Watt has to deal with.
Anglyn: The only comment I would make, and this is more towards the multifamily product, is that the appetite for multifamily lending is extremely strong. I think the key issue is relative costs of capital. The life companies have a very good capital structure, but they cannot always compete with Freddie Mac and Fannie Mae on rates. I think as Freddie and Fannie pull back, you are going to find adequate capital to fill in, albeit at a slightly higher rate. I would say that multifamily is the preferred asset class by many investors, and by virtue of that, I think the rate increases will not be as significant as some fear.
Fink: I can back up what Ted is saying. We have a lot of insurance company clients. They always tell me that there is not enough multifamily assets that they can get their hands on for investing in their loan portfolios. That doesn’t mean that they are going to invest in every property that Freddie and Fannie invests in. You have to decide what is the right target for federal tax subsidies and federal tax dollars. Even the federal government doesn’t have an unlimited access to money. You have to decide where to spend those dollars wisely and efficiently. I did subsidized housing during early in my career. There is a group of people who need to have housing, that can’t necessarily pay the full freight of a market-based pricing. That portion of the population has to be served, generally some combination of grants and subsidized loans in order to bring the overall costs of the projects down to the point of being affordable.
CPE: Are there any pieces of policy or economic trends that aren’t fully on the radar screen, but could have a big impact on commercial real estate?
Conway: Congress’ track record on dealing with important issues isn’t great right now. For three years, Congress has not moved on Water Resource Development Act funding or legislation. It puts our whole port infrastructure on the line as we are getting ready for the Panama Canal expansion, which brings more trade and more ships. So the House has gut it our, and the Senate is dragging its feet on taking up action. In the mean time, you have critical ports like Savannah, Charleston and the ports in Florida unable to get the funding to proceed with their dredging. The states are having to fund it instead.
Anglyn: Well there is whole issue of energy. Natural gas — and its expansion and potential for savings — is tremendous. I think that it is going to be the big benefactor for many parts of the country going forward.
Conway: One last thing I’d like to add, and this goes back to the Panama Canal expansion, as well as ecommerce, is that definition of a core industrial market is expanding and changing pretty dramatically. Ten years ago someone might not have considered Memphis as a core market for industrial. Today it is the world’s busiest air cargo market. Louisville is home to UPS. It is becoming a core market. It is these markets with modern intermodal facilities that can connect to the ports. A good example is Greenville-Spartanburg.
One of the neat things to watch over the next decade — the first post-Panamax decade — is going to be the change in the definition of what core is. The reason this is important, is that if capital doesn’t recognize the new core markets — which are today recognized as secondary markets — and starves them out of construction, we could really have a problem with fulfilling our growth and manufacturing opportunities.