Investors See Feast or Famine as Capital Markets Stir Optimism

Posted on February 10, 2011

Enter a real estate investment conference room today, where virtually every participant is now a reinvented asset management specialist, and a predictable conversation emerges. A chat with attendees — be they investors, lenders or third-party operators — leads one to hear a tale of two opinions with virtually no middle ground.

On the one hand, investors who hold assets in primary markets have already seen turnaround signs, even though some soft patches may still exist. On the other hand, some struggling secondary and tertiary markets are still waiting for capital to begin flowing their way.

The line forms here

To the owners and investors in large primary markets like New York, Washington, D.C., and London, the risk of further declines stands at virtually zero percent. A flurry of leasing and purchase activity is leading to talk about too much capital floating around and a potential new real estate asset bubble.

Although market participants either sharply criticize or wholly embrace the low interest rate environment, the result is a new stream of lending transactions due to more leasing activity.

When Brookfield Office Properties announced in November that the Bank of China Ltd. is lending the property investor and manager $800 million to refinance its 245 Park Avenue office building in Manhattan, the deal confirmed what many believe to be the basis for a sustained real estate recovery.

The transaction followed Brookfield’s recent 500,000 sq. ft. lease agreement with the French financial giant Société Générale. The deal reflects an emerging dichotomy: the lending business is back in vogue, albeit mostly for stable trophy assets in primary investment markets.

But the source of many loans is the most interesting aspect of recent funding and investment activity. Banks are now back in the business, suddenly reversing their state of hibernation that started with the collapse of the capital markets in the fall of 2008.

The Federal Reserve, in its quarterly bank survey, reported that some 27% of surveyed banks have eased their lending standards and are accumulating loans (see table). Major money center banks such as Bank of America, JPMorgan Chase, and Wells Fargo are searching for top talent in the loan origination and deal packaging business.

True testing ground

The best way to determine the sustainability of this real estate recovery rests in how the less glamorous markets, including the non-coastal cities, fare in this feast-or-famine scenario.

As the industry continues to struggle with billions of dollars of properties that are valued at less than their mortgages, some believe there is another downturn to come.

The widely followed New York multifamily complex, Stuyvesant Town and Peter Cooper Village, has reportedly been valued at $2.8 billion, less than the senior mortgage of the sprawling development and just about half its 2006 sale price of $5.2 billion. Even so, belief in an impending major downturn appears to be fading with every passing day.

The hunt for higher yield appears to be the overwhelming reason to support this optimism. Capital is now chasing real estate again, and it is only a matter of time before real estate investment capital becomes less disciplined.

That script is already playing out as high-yield corporate bond sales hit a record $12 billion in December, according to Bloomberg, eclipsing previous records set in almost every month since April.

Corporate bond yields stood at over 7.3% by mid-December, outstripping 10-year U.S. treasury bonds by the widest margins in about 10 years.

The emergence of CMBS 2.0, the name given to the new breed of transactions for commercial mortgage-backed bonds, has brought a new sense of optimism as bond issuance is meeting solid demand, according to bond traders.

Banks are leading the charge to provide CMBS 2.0 funding and are among the top ranking names that sold approximately $11.6 billion in bonds in 2010 compared with $2 billion in 2009.

Wall Street is back in the real estate finance and capital markets saddle. But once investors snap up the good deals in the top-tier markets, the capital machine will roll its way into the secondary and tertiary markets, where good deals can still be had for now.

Joe Caton is a South Florida journalist who provides training and development services to real estate finance professionals.