Real Estate Investment: Optimism vs. Cautions
A Wall Street Journal article in November titled ‘Trouble Brewing in Commercial Real Estate’ paints a bleak picture of the $11 trillion sector in 2017. As someone who works with debt and equity capital providers on structured finance transactions in good times and on workouts in not-so-good times, I would characterize the market in terms of opportunity more than danger—although both elements are present.
The Journal article focuses on the rising commercial mortgage delinquency rate, driven by CMBS loans made in 2006 and 2007 that can’t be refinanced conventionally today. That’s largely because CMBS issuers and banks face new regulations that limit their ability to make high-leverage loans. So there’s often an equity gap between expiring high-leverage mortgages and the lower-leverage loans that banks and CMBS originators offer today; however, the situation is far from dire.
There are plenty of sources for mezzanine debt and equity financing, as long as a property has positive cash flow. We’re busy helping owners and capital sources structure these deals, and we’re not busy handling workouts, as we were for years during and after the recession. Occupancy rates and rents are rising modestly in most markets and in most property types, and the economy appears to be in good shape, with low unemployment, modest wage growth and steady GDP growth. Capital sources like the risk-adjusted yields they can get from real estate, compared to most other asset classes.
The article also made much of an increase in apartment vacancies during 2016, which is true but only half the story. Apartment rents rose 4.6 percent in 2015 and 4 percent year-over-year in the second quarter of 2016, according to WSJ articles earlier this year. In recent months, apartment rents have dropped slightly and vacancies have increased from their historic lows, but these should be seen as minor corrections rather than signs of major trouble.
This is a good time to be cautiously optimistic about real estate investment. Too much optimism and not enough caution can lead to a market crash. But the current regulatory environment is causing lenders to be extremely risk-averse, and too much caution can lead to a shortage of supply that would be unhealthy for the economy as well.