Through the looking glass


How will interest rate hikes and Dodd-Frank affect commercial real estate in 2017? Mitch Paskover, president of Continental Partners, takes a look ahead

How will interest rate hikes and Dodd-Frank affect commercial real estate in 2017? Mitch Paskover, president of Continental Partners, takes a look ahead

Last year was one of tremendous growth and transition. This past year, we saw the market react to the newly elected president of the US, and experienced a period of post-election uncertainty regarding the impact of the new administration on the commercial real estate sector.

With the US Federal Reserve raising interest rates and additional Dodd-Frank Act regulations taking effect, many are wondering what the future has in store for commercial financing and investments. Will we continue to see healthy lending activity for commercial assets, or will the interest rate hikes and new risk retention rules create turbulence and uncertainty in the financial market?

Here is what real estate investors should expect in regards to financing their assets in 2017.

Slightly higher cost of capital

After nearly a decade of historically low interest rates, the Federal Reserve has raised rates by a quarter of a percentage point.

While some have expressed concerns about the increased cost of capital, the reality is that many lenders saw this coming and have already priced in the hikes in their underwriting and loan originations.

The effect of this rise in interest rates is two-fold. Lenders are exercising caution and lowering their loan proceeds, which in turn means that investors will require more equity to finance their acquisitions or development projects.

At the same time, borrowers will now be incentivised to refinance and will pursue long-term loans to lock in lower rates.

With this in mind, many borrowers are requesting fixed-rate loans to eliminate the interest rate risk over the next several years.

The implication is that any additional rate hikes will only affect floating rate loans and will not affect borrowers that refinance with a fixed-rate structure.

Ultimately, these interest rate hikes will not significantly affect lending activity. Interest rates still remain close to historic lows, relative to the double-digit rates we saw in the 1980s, and this could result in favourable conditions for financing and investing in real estate.

Cautionary approach to CMBS lending

In December 2016, a new commercial mortgage-backed securities (CMBS) bill under Dodd-Frank was passed, requiring lenders to hold onto 5 percent of the loans they issue, as opposed to selling them off as bonds.

Originally designed to protect issuers against risky lending, these risk retention rules may have far-reaching implications that could potentially impact CMBS lending.
By requiring lenders to utilise more of their own capital, the new CMBS bill may drive down their profit margins, pricing many of the smaller lenders out of the market.

The larger lenders that remain may scale back on the number of loans they originate due to the increasing cost of capital. CMBS lenders in general are being more conservative when it comes to financing assets, especially for high loan-to-value lending.

In the past, CMBS was the go-to source for class B and C assets in secondary and tertiary markets. Now, borrowers are looking to other capital sources to fill the gap in CMBS lending. Therefore, while CMBS lenders will still originate loans, they will simply be more selective in the deals they finance and more cautious in their underwriting standards.

It’s also important to note that President Donald Trump has discussed potentially reversing the Dodd-Frank risk retention rules. Under Trump’s administration, many industry leaders anticipate a loosening of regulations, which would spur financing and investment activity. That said, it still remains unknown as to whether a repeal of this law would take effect.

Availability of capital

While the CMBS market may experience some volatility, the overall availability of capital will remain the same in 2017. As such, there will continue to be a rush for capital, and borrowers will be more aggressive with their terms.

Borrowers are seeking out the most competitive debt financing available, especially fixed-rate loans to mitigate the uncertainty surrounding future interest rate hikes.

For example, we recently refinanced a 152,719-square foot shopping centre in Sacramento, California. The sponsor, a private equity real estate investor that specialises in value-add investments, needed to refinance the property to cash out the proceeds to invest in other assets.

We sourced a number of lenders and structured a competitive fixed-rate swap product that would allow the sponsor to generate additional yield should the prime index increase. This essentially enables the sponsor to benefit from the security of a fixed-rate loan while also making money through the swap exchange.

Overall, we anticipate healthy lender competition given the wide availability of capital in today’s market. This is especially the case for asset classes such as multifamily and industrial, which are seeing heavy lender appetite based on strong fundamentals.

Looking ahead, the financial landscape in 2017 will remain strong. Despite the uptick in interest rates and new CMBS legislation, we will continue to see healthy lending activity and ample sources of capital in the year ahead.
Features
The latest features from Real Estate Investment Times
Attendees at this year’s EPRA conference were forced to reckon with the social and political challenges facing the industry on a global scale
International institutional investors want in on the private rented sector in the UK, says independent property expert Sam Collins
Join Our Newsletter

Sign up today and never
miss the latest news or an issue again

Subscribe now
Alternatives continue to see rising demand from institutional investors in the Canadian marketplace. Tim Rourke, vice president of pensions and asset owners at CIBC Mellon, discusses how the country is well placed to meet it
Fund managers expect the private real estate industry to grow over the next three years, but Preqin’s Oliver Senchal warns against market consolidation
New regulations from the ECB have given real estate investors a lot to think about in the non-performing loans market, but appetite remains strong. Theo Andrew reports
Paul Conroy, real assets director at Aztec discusses the relationships behind co-investing and explains why it’s important to make sure it’s not just a marriage of convenience
With the number of cloud-based investment platforms seemingly increasing by the day, brokers are feeling the squeeze of a more efficient and transparent process, but there is room for both
Green investment is now recognised as generating higher returns, but more transparency is needed to attract investors, as Theo Andrew finds out
Country profiles
The latest country profiles from Real Estate Investment Times
Between Brexit and post-crisis recovery, Frankfurt’s office sector is booming, with particular interest coming from the world’s financial institutions, according to Andreas Krone and Lenny Lemler of NAI apollo
Africa has long been coveted as the land of real estate opportunity, but more needs to be done at a local level to break the market, heard attendees at the Second West African Real Estate Forum in London
Asset Servicing Times

Visit our sister site
for all the latest asset servicing news and analysis

assetservicingtimes.com
Callum Young of Savills tells Mark Dugdale why South Korea’s real estate market is attracting both domestic and international attention
UBS Asset Management Global Real Estate has launched a new business initiative in Brazil, in partnership with Brazilian consultancy Real Estate Capital. Senior adviser Miose Politi explains
A member of the EU since 2007, Romania boasts a property market that has been on the up ever since. Liviu Tudor of the Romanian Association of Building Owners explains
Alternative allocations are becoming mainstream for institutional investors, and Canadian companies are leading the pack, says Claire Johnson of CIBC Mellon
Amid cross-border restrictions and tightened belts, Luxembourg’s kingdom of real estate investment won’t be crumbling any time soon
Interviews
The latest interviews from Real Estate Investment Times