Commercial Real Estate Markets Heating Up as Interest Rates Trend Downward

The markets, like the temperatures in most parts of the U.S.,  are heating up with the arrival of  the summer months, according to the latest Scoreboard from The Real Estate Capital Institute based in Chicago.

Once again, interest rates continue trending downward to some of the lowest levels ever seen and spreads narrow as funding sources case prime quality investments.

Investors are rethinking and retooling their funding programs based on the following:

Higher Leverage:  To stay competitive, creative lenders are teaming up with Mezzanine debt players to provide a “one-stop” funding solution based on a higher leverage loan.  The combined leverage often results in loans of up to 85% with blended interest rates in the 6% or higher range, a premium over conventional first mortgage debt.

Mezzanine/Preferred Equity:  With yields tightening in the lower single-digit range, the preference for entertaining more equity rather that debt risk is appealing. Targets of 15% or more are still available within

this funding format.  However, the amount of higher-quality projects are bid up quickly, even in challenging markets as many investors are squeezed out of primary markets.

Alternative Property Types:  Existing “value add” opportunities for favorite property types are sparse.  Lodging, self-storage, data centers, flex industrial/office are gaining attention. Overall yields for such properties also are approaching the mid-teens for stabilized assets, while repositioning and value creation situations approach 20% or more.

New Construction:  A small window exists for new construction, as lenders are reentering the marketplace with construction funds. Through most of 2012, new-construction will be limited, but investment pipeline is increasing for hard-to-find investments, particularly multifamily assets which are trading at pricing close to replacement costs.  Since interest rates are extremely low, return on development cost are approaching a very narrow band, often within 100 basis points or less of the “exit” capitalization rate.

Jeanne Peck, research director for The Real Estate Capital Institute, forecasts “very little room remains for absolute rates to drop further.”

Peck thinks, “the main focus must be on improved cash flow performance through expense reductions and more aggressive income growth, where available.”

The Real Estate Capital Institute is a volunteer-based research organization that tracks realty rates data for debt and equity yields.  The Institute posts daily and historical benchmark rates including treasuries, bank prime and LIBOR

Source:  World Property Channel

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