Thursday, October 8, 2009

October Market Watch: Commercial Real Estate Loans and Economic Recovery

In recent weeks, many media outlets have reported that the worst is over and the US economy has bottomed out. Unemployment rates are still rising, currently at 9.7%, but at a declining rate. The S&P rose by 15% in the second quarter and by an estimated 12% in the third quarter. The Dow is inching toward 10,000 again after bottoming out near 6,500 in early March. Household net-worth has grown 3.9% from the first quarter 2009, the first such increase in 24 months. These are all good signs that the worst may be over on a national economic scale, but how does this translate to the commercial real estate market and commercial real estate loans?

Commercial real estate, especially in Seattle, will lag the trend. Many industry professionals see the next 18 months as the bottom for commercial real estate. Properties are just beginning to feel the effects of the unemployment increase. The market is offering leasing concessions as leases roll while companies decide how to improve their bottom line. Many of the outstanding loans that were originated 5-10 years ago are performing now, but will be stressed when they need to be refinanced in the next 24-48 months. Lenders will continue to tighten underwriting as property values decrease due to cap rate inflation and lower rents. LTV ratios for new loans are significantly less than in recent years, and market fundamentals are causing a decrease in NOI at most properties. These factors are stressing lenders’ real estate portfolios. There will be an estimated $1.4 trillion of loan maturities from CMBS, Life Insurance Companies, and banks over the next 5 years, the same amount maturing over the last 15 years.

Today’s commercial real estate loan will be more conservative; it will have a higher underwritten cap rate, increased underwritten vacancy, “market rent” adjustments, and a lower loan-to-value. Most investors are still sitting on capital, waiting to invest. Despite all this, for quality, well-performing assets, there is money ready, willing and available. Expectations are that there will be increasingly more capital available in 2010 as lenders compete to earn yield on cash. Rates are still near all-time record lows and owners are encouraged to lock in an attractive interest rate for a long term to avoid having to go out to the market in the next 12-48 months.

Issues Affecting Commercial Mortgage Rates:
· Falling treasury rates and compressing spreads provide attractive interest rates to borrowers seeking conservative commercial loans
· CMBS delinquency nearing 6.5%, more than 6 times the amount 12 months ago
· Unemployment, increasing vacancies, and declining rental rates impacting property net operating income.

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