Magazine article Real Estate Issues

Commercial Real Estate - Global or Local?

Magazine article Real Estate Issues

Commercial Real Estate - Global or Local?

Article excerpt

INTRODUCTION

Commercial real estate has traditionally been considered a local business, based upon locational characteristics and intimate knowledge of tenant needs. Trans-national real estate investment in the decade of the 1980s coupled with globalization of money and capital markets in the 1990s has caused some to believe that commercial real estate is a fungible commodity, which may be traded broadly irrespective of local needs or characteristics. This manuscript attempts to describe some of the linkages between global and local real estate. We shall begin with a brief survey of U.S. real estate capital markets, move on to the international capital markets, and conclude with a statement of how a local business - real estate - can react to global capital markets.

U.S. CAPITAL MARKETS FOR COMMERCIAL REAL ESTATE FINANCE

Perhaps the leading query is: how much longer can our longest sustained growth boom continue without running into inflationary pressures? There does appear to be a whiff of inflation in the air. Labor cost increases are disguised in part by signing bonuses, trips to Hawaii, annual bonus awards, stock options, and the like. Yet many localities are operating at under three percent unemployment, a statistic below traditional reckoning of frictional employment levels. Shortages are appearing in items such as dry wall and copper. The Federal Reserve Bank is practicing a balancing act between keeping interest rates low until the Asian crisis is resolved and moving to higher rates to avoid longer term inflation. Most economists seem to be predicting good growth through the year-2000 Presidential election and a possible shallow slow-down in 2001, caused in part by higher interest rates.

Certain economists posit that the Federal Reserve may have to raise interest rates even if there is low inflation, in order to cut off excessive consumer demand. Such excessive consumer demand has been fueled by the stock market bubble as well as the large disparity of imports over exports. Should the Fed take corrective action to stem excessive consumption and asset value inflation, a recession could easily be the result.

Meanwhile, the competition between public and private sources of capital continues. Insurance companies and commercial banks continue to benefit from Wall Street's liquidity squeeze in the last half of 1998. Spreads on real estate lending remain quite high, compared to the first half of 1998, although availability of funding has improved. Commercial banks remain aggressive on underwriting standards in selective cases. Insurance companies are aggressively marketing whole loans, syndicating such investments among two or three entities, seeking ways to justify higher loans to value and seeking to standardize mortgage documents.

In the public markets, real estate investment trusts (REITs) still represent a relatively small percentage of the commercial finance market. Prices of REIT stock remain depressed as large capital flows continue into Internet, media, and finance companies. The public markets think something bad is going to happen to real estate. REITs have become recognized as slow growth vehicles, somewhat underleveraged from a real estate point of view. They have moved from trading at 15 percent to 20 percent premiums to net asset value to trading at 15 percent to 20 percent discounts to net asset value. Those REITs that are able to reduce expenses, build ancillary businesses, and provide accretional external growth will do the best. Stock repurchases also can improve value. In the long run, the number of REITs will decrease sharply.

Commercial Mortgage Backed Securities (CMBS) have not recovered to the values they represented in 1998. CMBS pricing spreads to 10-year Treasuries remain relatively high for each rating category, and especially high for the lower rated tranches. The "bottom" pieces are priced at spreads to Treasuries roughly double those of early last year. …

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