With approximately $700 billion worth of loans coming due on distressed properties over the next four years, transaction activity in commercial real estate is picking up this year, albeit slowly, and is expected to intensify in 2011 and 2012.
Investment capital that had been waiting on the sidelines from mid-2008 and the first quarter of this year is getting back into the game as confidence returns in the form of the market’s stabilizing fundamentals.
“For example, life insurance companies, a traditional source of capital, are back in the market,” says Craig Butchenhart, the president and director of capital services for NorthMarq Capital, a national firm that offers commercial real estate investment banking. “And as more traditional sources come back to the market, there will be available capital to access.”
Many of the loans originated in 2006 and 2007 — the height of the commercial real estate boom — come due in 2011 and 2012. Morningstar, an investment resource specializing in fund investing, believes that will create an environment that fosters asset sales more aggressively than in 2010. To date, 2010 has produced better opportunities for refinancing than outright asset sales.
“Most institutions that we deal with believe that values are fairly stable now,” Butchenhart says. “Confidence that fundamentals are stabilizing and not deteriorating further is bringing these institutions back to the market.”
Of course, available capital is just one aspect of the picture. Financial institutions are lending again, but underwriting requirements remain conservative as stronger cash flows continue to be required as well as longer leases, and the ability of the borrower to pay back its loan.
CMBS signs of life
One surprise that may generate more transaction activity in the near future is the return of the commercial mortgage-backed securities (CMBS) market. Many analysts hadn’t expected the CMBS market to turn around this early after it was considered dead for nearly two years during the recession. Since then, few CMBS-backed deals have occurred as investors and issuers, aware of the creditworthiness risks involved, painstakingly do their homework on these securities.
In June, JP Morgan Chase Commercial Mortgage Securities Corp. issued a $716.3 million CMBS-backed bond, primarily consisting of retail properties, in the second such deal this year.
“There’s a little life in the CMBS market,” Butchenhart says.
There’s significant maturity in the CMBS loan pipeline, and most of those maturing CMBS loans are being refinanced due to low interest rates as they are maturing at rates higher than the current interest rates. If they can’t be refinanced, the CMBS loans are being modified or extended for a period of time as the borrowers await capital.
“As long as those properties have maintained a reasonable amount of leasing, loans can be refinanced,” Butchenhart says.
But finally, firms like NorthMarq Capital are witnessing available capital come to the market spurring more transactions.
Properties of choice
So, which property types are providing homes for these transactions?
High-quality, well-located properties.
“There seems to be a split personality between high-quality, well-leased properties in which there are a significant amount of bidders, and class B and C properties, or properties in secondary or tertiary markets, which aren’t seeing many bidders,” Butchenhart says.
Butchenhart believes, though, if real estate fundamentals continue to improve, lower-class properties will also begin to see increased attention. And he doesn’t see fundamentals suffering unless the market witnesses a double-dip recession, which isn’t foreseen by NorthMarq Capital.
Office properties are leading the way in average price per transaction at $31.8 million, according to Real Capital Analytics. However, that figure is skewed by the majority of office transactions occurring in large cities for Class-A properties. Lower class office properties as well as the secondary and tertiary markets haven’t seen nearly the same transaction level.
In San Francisco, American Real Estate Capital recently closed on a $21 million loan for the refinance of 633 Folsom Street in the South of Market neighborhood. The seven-story, 171,000 sq. ft. office building is 100% leased to California Pacific Medical Center, and is managed by the Swig Co. The Coral Gables, Fla.-based lender represents insurance company lenders that are part of American Financial Group.
Meanwhile, in Edina, Minn., NorthMarq Capital recently arranged first mortgage financing of $13 million for Centennial Lakes IV. The 215,790 sq. ft. Class-A office property is part of a 100-acre, mixed-use development that includes a 25-acre park in suburban Minneapolis. Financing was arranged for the borrower through NorthMarq Capital’s relationship with Minnesota Life Insurance Co.
Those are just two examples of the 478 office transactions that have taken place since January 2010, which trails the number of retail transactions over the same period, 697 deals, averaging $13.5 million per sale, according to Real Capital Analytics.
Meanwhile, the hospitality and specialty sectors are still lagging behind other property types. But American Real Estate Capital has found a way to deal with specialty property types evidenced by its recent $57 million loan for the refinancing of the Lauderdale Marine Center, the largest boat service facility in south Florida with yacht sales operations, marina, and boat service and repair facilities.
Philip Carroll, president of American Real Estate Capital, says that specialty property types lean on the lender/borrower relationship, and need to have a strong, experienced operator of the property.
“We won’t touch a specialty property in which a couple of investors came together, bought it and decided to run it,” Carroll says. “It has to have a really strong operator with 10, 20 or 30 years of experience that really knows what they’re doing.”
