On October 5th ULI members gathered at Cushman and Wakefield’s Santana Row office in San Jose, for a discussion on capital markets and current conditions surrounding raising capital for commercial real estate projects. With regulatory complexity increasing post-recession and risk at the forefront of deals, dynamic investment strategies have become a necessity in today’s market.
Moderator Mike Jameson, Managing Director at Prudential Mortgage Capital Company set the stage with some broad observations of the market before diving in to some more pointed questions for the panelists. The panelists, with decades of market insights amongst themselves, included; Jean Baker, Managing Director at LoanCore Capital, LLC; Brandon Buza, Director at Northwestern Mutual; Brian Heafey, Partner at PCCP, LLC; and Anna Chambers, Senior Vice-President at Bank of America Merrill Lynch.
Of particular relevance to the commercial market, is the idea that an increased pull towards urbanism is challenging traditional suburban markets, resulting in a slowdown of suburban office development. Hugely important, but somewhat uncertain is how the maturation of tens of billions in commercial mortgage-backed security (CMBS) loans will impact the market over the next few years. Although post-recession tenant strength is up and vacancy rates are down, credit is becoming constrained and losses from some large retailers are eating into the refinancing of these loans.
On the lending side scenarios have become increasingly selective. The High Volatility Commercial Real Estate “HVCRE” regulation, as laid-out by the Basel III requirements mandates that loans must meet a 15% equity or marketable securities requirement to be exempt. If conditions are not met, then loans will be designated as a high volatility risk and subject to a risk weight requirement. Furthermore, in accordance with Basal III 100 percent of the capital against the loan must be provided on the first day of lending. From the point of view of lenders all this begs the question, who should I lend to? With the market seeing somewhat slower rates of growth and stricter capital requirements, loans are going to clients with strong lender relationships and healthy balance sheets.
While things have increased in complexity from deal to deal, there were a number of encouraging takeaways. As the panel noted a low-yield environment is not inherently unfavorable, mezzanine debt can function as an attractive option within the capital stack given current debt yields. Another key observation, is that that the best opportunities appear to be presenting themselves on the construction side, specifically deals suited to long-term holders.
Ultimately, as demand constraints increase according to what people can pay and construction costs continue to rise the market is pushing the limits of affordability on both ends. It is clear that loan refinancing buy-in, interest rate adjustments, and regulation will be key determinants to how the market adjusts.