There aren’t many places for money to go these days. The stock market continues to bounce around, and another spike always seems to be just around the corner. Bonds are producing low yields, and given the run-up in bond prices in recent years, money could begin to pour out of bonds and leave investors with the unsatisfying combination of low income and capital losses.
Almost by default, equity capital looks to real estate to provide a better combination of income, capital gains and preservation. However, that capital tends to be highly selective, often only willing to place a stake in the best performing real estate in the most attractive locations. Despite the availability of capital sitting on the sidelines in the form of pension funds, hedge funds, private investors, insurers, private equity firms and real estate investment trusts, many commercial properties remain without buyers.
The banks that own distressed properties appear to be in no rush to sell and recognize the losses. Correspondingly, despite ongoing economic growth (10 consecutive quarters) and the fact the nation added 1.64 million jobs during the past year, the marketplace continues to approach equilibrium slowly.
At the same time, a shortage of debt financing remains available to commercial real estate. Nearly 63 percent of respondents to a PriceWaterhouseCoopers/ULI survey believe debt markets will be moderately to substantially undersupplied in 2012, largely due to the spotty recovery in the marketplace for collateralized mortgage-backed securities and bankers’ reluctance to lend when interest rates are so low. For commercial builders, this means the recovery in many segments, including office buildings and hotels, will continue at a grinding pace. In fact, the recovery could stall. A majority of survey respondents forecast that underwriting standards would remain the same or become even more rigorous on debt and equity in 2012.
A recent report from the American Institute of Architects
(AIA) concludes the major obstacle to job creation in the United States is the persistent lack of construction financing. The report also found the number of projects stalled due to financing issues nearly doubled from 2008 to August 2011, and financing issues account for a higher share of stalled projects in the education sector and are less of a factor in manufacturing, health care and retail environments. In response, the AIA launched an online database
of stalled projects intended to connect developers with financiers to re-ignite mothballed building plans.
To a certain extent, the cautiousness of lenders is understandable. According to Trepp, LLC
, banks charged off approximately $22.2 billion of commercial real estate loan losses in 2011, resulting in a cumulative total of $122.5 billion in charge-offs from 2007 to 2011. These issues have been particularly acute at smaller banks, which are often more exposed (at least proportionately) to commercial real estate. While commercial real estate loan losses accounted for almost 20 percent of charge-offs for all banks during the last four years, they comprised more than half of charge-offs for community banks in the $100 million to $10 billion asset size range.
One increasingly important source of financing is foreign capital. According to Real Capital Analytics
, foreign investment as a percent of total investment in the U.S. commercial real estate market expanded to 12.3 percent as of July 2011, compared to 8.4 percent one year prior. Investors from Canada, Switzerland and South Korea accounted for nearly 55 percent of the total.
One of the exceptions to the capital-constrained environment is the nation’s multifamily construction market. Many analysts expect financing will continue to be available for apartment construction, particularly in gateway cities such as New York, Boston, Los Angeles, San Francisco and Washington, D.C. David Rifkind, managing director of George Smith Partners, Inc.
, suggested “there is easily three times the number of lenders operating in the new multifamily construction space at the end of 2011 as there was at the beginning of the year.”
Moreover, construction loan interest rates are considered to be phenomenal. As of Jan. 31, all-in bank loan rates were at 3.25 percent to 4.25 percent. Underwriting standards, however, remained conservative, with loan-to-cost typically in the range of 65 percent to 70 percent. The implication of these circumstances is the recovery in apartment construction is likely to continue to be robust. However, with so many lenders and investors focused on this one real estate category, concerns regarding over-building have begun to emerge.