Urban Land Institute Real Estate Capital Markets Real Estate Finance in 2014: Return to Normalcy 1
Dec 15, 2015
Urban Land Institute Real Estate Capital Markets
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Real Estate Finance in 2014:Return to Normalcy
Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital Markets
2007: The “Beginning of the End”
“…the end of an economic illusion, facilitated by a
bubble, built on a delusion, perpetuated by greed,
living on both borrowed time, and borrowed money”
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Urban Land Institute Real Estate Capital Markets
We Told Ourselves: “This Time It’s Different”
U.S. housing bust pushed global economy into recession
Rental demand for commercial real estate “evaporated”
Federal Reserve flooded capital markets with liquidity, driving interest rates to near zero
U.S. government brokered mergers of shaky financial institutions (J.P. Morgan/Bear Sterns; B of A/ML)
U.S. government bailed out AIG, let Lehman fail, and allowed Goldman Sachs, Morgan Stanley, America Express, MetLife, et al to convert to bank structures and thereby qualify for bailout money
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Urban Land Institute Real Estate Capital Markets
We Told Ourselves: “This Time It’s Different” (continued)
Overall, largest government intervention into the financial system and capital markets…ever
To date, solutions have been short-term in nature with no evidence of a long-term, systemic plan
What was initially a liquidity crises became a crises in confidence as “civil discourse” between political parties seemed impossible
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Urban Land Institute Real Estate Capital Markets
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Real Estate Finance 2012: New Realities
Urban Land Institute Real Estate Capital Markets
“Two Speeches for Audience to Chose From”
For Speech A, text “A” to: 4-5-6-6-6 *
For Speech B, text “B” to: 3-6-6-6 **
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* 4-5-6-6-6 spells “gloom”; ** 3-6-6-6 spells “doom”
Urban Land Institute Real Estate Capital Markets
tenuous
ten∙u∙ous
[ten-yoo-uhs]-adjective
1. thin or slender in form, as a thread.
2. lacking in sound basis, as reasoning; unsubstantiated; weak: a tenuous argument.
3. thin in consistency; rare or rarefied.
4. of slight importance or significance; unsubstantial: He holds a rather tenuous position in history.
5. lacking in clarity; vague: He gave a rather tenuous account of his past life.
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Urban Land Institute Real Estate Capital Markets
2012: Between Uncertainty
and Extreme Uncertainty
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Urban Land Institute Real Estate Capital Markets
Becoming Resigned to Uncertainty
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Urban Land Institute Real Estate Capital Markets
Emerging Trends in
Real Estate 2013:
“Recovery Anchored in Uncertainty”
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Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital Markets
“Signposts for 2013…First Thoughts”
The 21 century became a teenager in 2013, and as with any young adolescent, it kept odd hours; tough issues seemed to get pushed off; and there were likely to be wild highs and lows
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Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital Markets
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Real Estate Finance in 2014:Return to Normalcy
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Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital Markets
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“If you laid all the economists end-to-end, they would never reach a conclusion”
George Bernard Shaw
“It has been said that the only purpose of economic forecasts is to make astrology look respectable”
Anonymous
Urban Land Institute Real Estate Capital Markets
Federal Open Market Monetary Policy
In December 2013, the FOMC began winding down its QE program by reducing asset purchases from $85 billion to $75 billion per month
The Fed also strengthened its forward interest rate guidance, making this a “Dovish Taper”
Policymakers noted that the fed funds rate would remain “at rock bottom levels well past the time the unemployment rate fell below 6.5%”
All-in, interest rates should remain at historical low levels through yearend 2014
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Urban Land Institute Real Estate Capital Markets
Federal Reserve Board Beige Book
Showed economic activity expanded at a modest to moderate pace across Federal Reserve districts from mid-November through early January
In the real estate sector, home sales ended the year higher than a year earlier in most districts as momentum slowed in several districts
Residential construction was generally stronger, led by multifamily construction
Conditions were mixed for commercial real estate markets
Commercial real estate construction is on the increase broadly, and the outlook for 2014 is generally positive
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Urban Land Institute Real Estate Capital Markets
U.S. economy: what to watch for
Risk spreads – narrower and steady
Inventories – building up in line with increased output
New factory orders – increasing, especially for capital goods
Unemployment claims – increased post-Sandy; now declining
Building permits – increasing moderately for single family residential and reluctantly for commercial real estate
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Urban Land Institute Real Estate Capital Markets
2011
Defensive strategies; focus on core markets; multifamily favored property class
2012
Continued focus on core markets/property; slowing cap rate compression; commercial real estate yields remain attractive
2013
Core markets and property becoming “too pricey”; focus turns to secondary/tertiary markets and overlooked sectors as values in many markets have returned to 2006-2007 “high-water” mark
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Urban Land Institute Real Estate Capital Markets
Say “Goodbye to 2013”
Continued improvement in fundamentals in all food groups
Property sales volume increasing
Vacancy rates down or declining
Equity and debt capital available from array of sources
Development activity is cautiously increasing
Federal Reserve began to “taper” bond purchases
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Urban Land Institute Real Estate Capital Markets
Say “Hello to 2014”
The Real Estate Roundtable Sentiment Index
Views of CEO, President, and other top officers regarding current conditions and future outlook on real estate conditions, capital markets, and asset pricing
Participants note continued improvement in fundamentals, but remain cautious due to slow pace of economic recovery
New construction and an increased tolerance for risk suggest optimism beyond the core “gateway” markets and multifamily sectors
Rising interest rates could undermine improvements in NOI, potentially putting renewed downward pressure on asset values
For now, the strong availability of capital (increasingly flowing to riskier transactions) is helping to offset the recent run-up in long-term interest rates
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Urban Land Institute Real Estate Capital Markets
Say “Hello to 2014” (continued)
Numerous “players” in the equity, debt, and property markets
Some think “Too many people, too many dollars, too few deals”
Some argue “we’re in a precarious position with the wind at our backs and capitalization and interest rates down…” for the moment and NOIs growing…slowly
Others caution “we’re in a precarious position with the wind in our faces, NOI growth “slack”, interest rates and cap rates ready to increase, and new supply on its way
Properties are “priced to perfection” or “priced to disappoint”
Too many people are focused on “buying yield, not creating yield”
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Urban Land Institute Real Estate Capital Markets
“Logistics”,i.e., Fundraising
Remains challenging for the majority of private real estate fund managers
Results indicate you need to be “big and global” or a “nimble and a local sharpshooter”
Key factor investors consider include: track record (32%); experience (30%); returns (27%); strategy (18%); risk profile (18%); and fees (14%)
Largest domestic and foreign institutional investors, wanting greater control over investments, are focusing on direct investments, joint ventures, and other forms of structured transactions
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Urban Land Institute Real Estate Capital Markets
Real Estate Equity Capital Markets
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Urban Land Institute Real Estate Capital Markets
Property Transaction Trends
As of 3Q2013, transaction volume equaled $293+/- billion, 27% ahead of 2012
Multifamily remains in the “wonder” zone with investor’s wondering if too much is under construction and if pricing is sustainable
Investors appear to be rotating to higher yielding, higher risk plays such as hospitality, retail, and niche property types
Geography continues to expand to include formerly overlooked secondary and tertiary markets
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Urban Land Institute Real Estate Capital Markets
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $-
$100.00
$200.00
$300.00
$400.00
$500.00
$600.00
$88.30 $104.70
$129.50
$209.90
$359.00
$415.50
$570.70
$171.70
$66.20
$142.60
$229.20
$283.20
$315.00(e)
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Transaction Volume
Urban Land Institute Real Estate Capital MarketsRanking of Investment Categories and Strategies
Value-added Investments
Development
Opportunistic Investments
Core-Plus Investments
Core Investments
Distressed Properties
Distressed Debt
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Urban Land Institute Real Estate Capital Markets
Real Estate Investment TrustsContinue to enjoy broad access to capital from many public and private sources including common/preferred equity, unsecured debt, and balance sheet lendersContinuing to recycle lower tier assets, supported by increasingly active CMBS marketREIT conversions for non-traditional assets such as infrastructure, billboards, correctional facilities in processDividend yields and valuations remain attractiveNon-Traded REITs having another record year
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Urban Land Institute Real Estate Capital Markets
Real Estate Debt Capital Markets
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Urban Land Institute Real Estate Capital Markets
Debt Sources
“New and improved CMBS”, a.k.a. CMBS 2.0 is taking market share from competitors
CMBS’s ability to process B and C quality property in secondary and tertiary markets is a competitive advantage not lost on borrowers
CMBS 2.0 has also learned to compete with commercial banks and insurance companies for mandates on core property in primary markets
No new credible source has entered the market since the end of the current crises as spreads are only marginally attractive compared to alternative investments
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Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital MarketsCumulative Distress for All Property Types
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Urban Land Institute Real Estate Capital Markets
Sector 1/4/2013(in Basis Points)
12/13/2013(in Basis Points)
Change (in Basis Points)
Office 210 162 -48
Retail 192 160 -32
Multifamily 182 157 -25
Industrial 191 159 -32
Average 194 160 -34
10-Year Treasury Bonds 1.86% 3.04% +1.18%
10-Year, 50%to 59% Loan-to-Value
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Urban Land Institute Real Estate Capital Markets
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CMBS Issuance: 1995 – 2014 (Projected)
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132013
2014$0
$50,000
$100,000
$150,000
$200,000
$250,000
U.S. ($Mil.)Source: Commercial Mortgage Alert.
Urban Land Institute Real Estate Capital Markets
Commercial Banks
Against a backdrop of deleveraging and reduced exposure to acquisition, development, and construction lending
2011: commercial banks started to test the water
2012: commercial banks began to put their toes in the water
2013: switch from loan resolution to loan origination
2014: anticipated profitability will allow increase in originations and growth of loan book
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Urban Land Institute Real Estate Capital Markets
Life Insurance Companies
Will face stiffer competition in 2014 from both commercial banks as well as securitized lenders
Insurers “fighting back” with tighter loan spreads, higher leverage, and less recourse
Industry worries about a “race to the bottom” in the application of credit standards
Originations expected to equal $50 billion, long-term run rate for insurers
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Urban Land Institute Real Estate Capital Markets
Debt Funds
Developed to fill lender gap
Provides higher yields than equity with (hopefully) less risk
Not the savior everyone expected…as yet
Over time, may grow from niche player to important part of the capital stack
Will need to develop its own infrastructure
Focused on institutional size property and “Best of Breed” borrowers
Global geographic focus: U.S.; Japan; UK, Europe
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Urban Land Institute Real Estate Capital Markets
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Urban Land Institute Real Estate Capital Markets
“Prediction is very difficult, especially if it’s about the future”
Economy continues to “grind it out”
Interest rates “flat” through 2014
Real estate fundamentals continue to improve, benefitting from improving economy and little new construction
Transaction volume increases from $325 billion in 2014
Fundraising remains challenging
Competition for investments increases; buyers resort to “hand-to-hand” combat
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Urban Land Institute Real Estate Capital Markets
REITs remain ferocious competitors
Pension will increase allocations
Foreign investors focus on core assets in gateway markets (and political and physical safety)
Mortgage capital “abundant and cheap”
Mortgage delinquencies continue to decline
Refinancing dealt with promptly
Commercial banks: originations equal to $150 billion
CMBS: originations total $90 billion to $100 billion
Insurance: originations reach $50 billion
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Urban Land Institute Real Estate Capital Markets
Urban Land Institute Real Estate Capital Markets
“Best Bets”
Infill locations in 24-hour markets
Develop industrial property in hubs near ports and airports
Develop multifamily property…carefully
Scour the secondary and tertiary markets
Single family housing funds…maybe
Buy and hold REITs
Non-performing mortgage loans (if you can get any)
Anything with an “R” in it: refinance; renovate; re-position; rehabilitate; re-lease; restructure; recapitalize; etc.
The “Age Game”: seniors, students, and medical office
Distressed: think Europe
Food trucks: combine social media and prime locations
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Urban Land Institute Real Estate Capital Markets
“If it looks like a bubble, and floats like a bubble…
Summer 2013: inflection point or the pause that refreshes?
“Priced to perfection” or “Priced to disappoint”
Let’s role play for a minute; I’ll be the buyer and seller and the lender and the borrower
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Urban Land Institute Real Estate Capital Markets
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Real Estate Finance in 2014:Return to Normalcy