Commercial Real Estate Property and Interest Rates. What Future Do they Hold?

December 4th, 2013 by Diane Moore

Many experts predict that commercial real estate will get slightly better in this year. Additional construction endeavors will slowly climb upward, operating revenue will be somewhat better, and property values will level off. Afterward, in 2014 or 2015, operating earnings and prices will both increase, generating a growth in the construction sector.

Commercial Real Estate Property and Interest Rates

Commercial Real Estate Property and Interest Rates

The recession discouraged tenancy of offices, retail, and industrial spaces, which dragged rents down. Property owners experienced lower incomes. During the slow recovery, supplemental construction diminished to almost zero. Need for additional square footage was zilch, and those developers who desired to build for demand later on found that lenders were tentative about taking much risk.

 

The present circumstances show that leases are coming in slowly generating a tiny increase in occupied square footage. The present pace of construction is not only less than during the expansion, but significantly under historic averages. It is understood that given even middling economic expansion, a need will arise to build at a more vigorous pace. However, the high vacancy rates that are an inheritance of the recession will restrict additional construction at least through 2013.

Low Interest Rates Influence Property Values

 

Property values have stood up quite well despite dismal tenant growth due to low interest rates. If you consider a valuation as future revenue discounted by some interest-rate, then decreased interest-rates are a precursor to higher property values. The most excellent mortgage rates have been obtained on fantastic properties, good cashflow, and pristine tenants.

 

For these types of deals, interest is so cheap; it might as well be given away. Properties of lower quality have a much narrower-range of funding sources, resulting in increased interest rates. Superior quality commercial real estate has appreciated 6% in the previous year, with lower rates of gain for other buildings.

 

Though there will be an extremely small amount of construction activity in 2013, property owners will experience a small increase in occupancy. They will limit rent allowances, and these will assist operating revenues.

 

Interest rates will not decrease in 2013, and longterm mortgage rates may increase later in the year. Therefore, the operating income advances will not convert into additional increases in property values.

 

Brand new construction this year will be just a tad better than the year before. The real boost in activity will likely take place in 2014/2015, depending on the market region. Nationally, most of the expansion will not take place before 2015.

What Is Slowing Down the Commercial Real Estate Environment?

 

The United States CRE, commercial real estate, recovery, though sluggish, has been perceptible in enhanced fundamentals, capital accessibility, asset pricing, and transactions. Actually, REITs, Real Estate Investment Trusts, as an asset category continues to outdo others, especially because of higher liquidity and comparatively easy availability of capital markets.

 

Nonetheless, the CRE upturn seems to be shaky, with greater than before “caution” because of the nation’s mired economic recovery, which is due, in part, to sovereign debt difficulties and financial stagnation in Europe along with slowing growth in rising markets such as India and China. Furthermore, the negligible development activity going on does not augur well for future growth.

 

Considering the restricted support from the outside environment, commercial real estate participants should concentrate other tools to increase revenues, margins, and retain-tenants. Foreclosed one-family homes, which are growing into an alternative asset class, are progressively being viewed as an investment choice to capitalize on the dislocation in the US housing-markets.

 

In addition, there is an increased interest in opportunistic acquisitions in Asian, European markets, and expanding markets reaching for growth and diversification of investments. Commercial real estate players could benefit from a consistent focus on sustainability, seeing that it is inclined to affect investors’ and customer’s commercial property choices.

 

Furthermore, commercial real estate stakeholders can search through this demanding period and get ready for longterm growth by capturing the advantages of technologies such as enterprise mobility, social media, cloud computing, and advanced analytics.

 

The outlook for a broad commercial real estate market recovery is being delayed because of lukewarm CMBS issuance and growing caution towards loan originations and refinancing for “non-trophy” capital in secondary and tertiary markets.

 

Additionally, Dodd Frank Act and Basel-III requirements on enhanced risk retention necessities for CMBS and higher capital charges on bank commercial real estate loans will lead to greater origination and securitization expenses and stern eligibility criteria, factors that could restrict lending, add debt-cost, and result in a financing gap in the US commercial real estate markets.

Low Transaction Volumes in Commercial Real Estate

 

National Association of Realtors leading economist Lawrence Yun, united with several realtor commercial practitioners on a board to talk about financial and regulatory dilemmas and their effect on the commercial real estate market. Through a real time polling of the audience, most of the members articulated that their local economy is somewhat better or starting to show a huge improvement from last year.

 

“At this moment we are going through an interesting recovery period,” said Yun. “People in high income brackets are experiencing much improvement in the economy, especially those associated with stock market capital. Nonetheless, people in the lower income brackets are experiencing no growth in their income. Commercial real estate is relied upon the American economy, and with a jagged recovery, the market will have a ways to go before a full recovery can take place.”

 

Yun revealed that the general transaction volume in the commercial real estate market is gradually improving and that property sales are increasing. When it’s time to anticipate markets, New York City is at the top of the list as far as sales volume goes; however, Yun called attention to smaller markets like Austin and Seattle that are experiencing considerable yearly improvements. This proves that large investors are more apt to buy in midsize markets.

 

Though transaction volumes have been low in commercial real-estate, experts say that CRE sales are beginning to improve. Though the prices and deal sizes handled most often by realtors have yet to stabilize, a positive turn in sales volumes has been observed recently.

Who Is Financing Commercial Real Estate Deals?

 

Many US banks are starting to observe the new growth in commercial property loans, according to studies from SNL  Financial, who estimated $991.2-billion in total volume at the middle of 2013. The count is 3.3% more than at the same time last year. More banks are now on the offense and not resistant anymore when approaching commercial real estate, noted a very well known banking analyst.

 

In one recent poll, most members believed that credit availability for commercial deals is not perfect, but has improved from a year ago. The capital available and credit has opened up, but it is best to have a good down payment and an excellent credit history.

 

According to NAR data, commercial members received their financing most often from regional and local banks, including credit unions. However, many have stated that it is still problematical to receive credit because of regulatory stipulations and insecurity. Recent legislative and regulatory impacts such as the Dodd Frank Wall Street Reform and Consumer Protection Act have lessened the flow of capital in the US real estate market.

 

Nonetheless, there are a number of heavy-hitters that are financing the commercial real estate market:

  • Barry Sternlicht, Charman and CEO 

 

Starwood Property Trust is the country’s biggest REIT, has formally stepped into the big leagues, establishing itself as one of several companies able to supply the largest loans. As of the end of last year, the company had around $482 million of investments anticipated finishing in the fourth quarter of 2012.

 

The outlook was always positive concerning the Sternlicht empire. Fall 2012, Starwood Capital Group, which has $21 billion of capital under management, created a European real estate finance platform to benefit from the developing requirement to refinance existing loans, along with the ongoing demand for financing in Europe.

  • James Carpenter, Senior Executive Vice-President and CLO

 

In 2012, James Carpenter and his group sealed a $300 million refinancing deal for a thirty story office building on Park Avenue in Midtown Manhattan for a New York headquartered sponsor that is one of the largest proprietors and handlers of commercial real  estate in America.

 

Briefly, after finalizing the deal, NYCB brought in a key life-insurance company as a 50% co lender. The bank has kept the administrativeagent for the facility.

 

NYCB has launched itself as an unsurpassed commercial real estate lender in NYC. Their strategy is to close high volumes of quality deals with accuracy of execution.

  • Rick Lyon, Head of Commercial Real Estate, Capital One

 

Rick Lyon has directed a stabilizing era of growth at Capital One’s commercial real-estate division, where conservative lending is highlighted. In the New York  City region, emphasizes is positioned on the bank’s $6 billion multi-family housing portfolio primarily situated in the outer boroughs. Lyons and his group closed a $12.2 million lending deal for the sale of 141 units on DeKalb Avenue in the Bronx.

 

The team does not restrict itself just to those types of deals. They also managed the refinancing of the 702,815 square foot edifice at 40 Worth Street in the Tribeca area middle of 2012 with a $101 million first mortgage. 

Smart Building Investment

 

Environmental sustainability performance in real estates in general is of considerable interest to many, as buildings in the US account for approximately 41.0% of energy usage, 73.0% of electricity usage, 13.6% of potable water usage, and 38.0% of greenhouse gas emissions.

 

Investors and tenants property choices are increasingly affected by commercial real estate players adaptation of sustainability initiatives. Furthermore, local government planning and zoning associations today anticipate sustainability concern to be constructed into development plans prior to granting entitlements.

 

It is crucial, therefore, that commercial real estate players comprehend the business  sustainability, ignited by stakeholder expectations, and follow established frameworks for sustainability reporting and disclosure. Sustainability initiatives are a big part of smart building investment and can be a powerful motivator for developing innovative processes and operating models if all the risks and prospects are properly considered.

 

It could enable commercial real estate players to decrease operating costs, increase revenue, mitigate enterprise risks, and build brand value. Recent research of the effect of sustainability initiatives on REIT’s performance established that an increase in portfolio greenness improves the REIT’s return on assets ROA, return on equity ROE, and percentage of funds from operations FFO to income.

 

In addition, the study proved that listed REIT’s with a better proportion of green buildings exhibit considerable lower betas, implying superior risk adjusted returns.

 

By 2015, a probable 40% to 48% of new commercial property construction will embed sustainable building practices. Commercial and public property owners are looking towards smart building technology to boost operational efficiency, achieve energy savings, improve capital planning, and decrease their carbon footprints. These benefits, together with tenant penchants for smart building features supplies a competitive-edge for owners and investors.

Conclusion

 

Many believe that the commercial real estate market will improve in 2014.CRE experts believe that improved confidence amongst business owners will help to improve the economy bringing the commercial real estate market with it.

 

According to research and many real estate experts, a big turn around is anticipated for 2014 or 2015. However, the scrutiny of activity in various markets leads to mostly custom building in construction activity. Nevertheless, regulations are making it more difficult for those previously in the commercial real estate market to step back into the game. New construction activity will eventually move upward, operating income will be somewhat improved, and property values will level-off.

 

Generally speaking, the commercial real estate sector will likely boom again with interest rates fluctuating and properties going to the highest bidder but mostly those with the best credit. Nonetheless, commercial real estate is predicted to make a faster come back than the housing market.

 

 

Diane is a highly-qualified translator of the English, Italian and Spanish languages. She has studied extensively in Italy and Switzerland. She writes about a variety of financial services industries including insurance. She has a love of life and a curiosity that drives her both personally and professionally.

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