MARKET INSIGHTS
July 31, 2017

Andy Little

RICHMOND TIMES-DISPATCH

BY ANDREW LITTLE Special correspondent - Jul 16, 2017

Commercial real estate investors are like Boston Red Sox fans watching Aaron Judge hit home runs in the Home Run Derby.

The 6-foot-7 rookie sensation plays for the New York Yankees, but other than that, he’s hard to dislike.

Likewise, though investors are skeptical, it’s difficult to find a reason to dislike commercial real estate these days.

While commercial mortgage interest rates surged over the past two weeks by approximately 0.25 percent, rates remain extremely low and are prompting nonstop activity.

Rates are currently in the 3.5 percent to 4 percent range for 5- and 10-year mortgages from life insurance companies looking for lower leverage loans, according to the John B. Levy National Mortgage Survey.

Fuller leverage loans from Fannie Mae and Freddie Mac and conduits are pricing 0.50 percent to 0.65 percent higher for 10-year deals.

One of the biggest surprises at the halfway point in the year is that conduits finally have their groove back.

The first half of 2017 was supposed to be an adjustment time for the conduits as they worked through new regulations implemented in December 2016.

As it turns out, the first half has been quite good for the conduits. Volume in 2017 through June 30 is $38.8 billion, a 26 percent increase over 2016 during the same period, according to Commercial Mortgage Alert, a New Jersey-based industry publication.

The weighted average gross profit margin is more than 4 percent for 13 conduit transactions that closed in the first half of 2017, according to Commercial Mortgage Alert. While it has always been a murky question to answer, new regulations have made the opaque world of conduit profitability a little more transparent.

Not only are there fewer conduit lenders competing, but there are very few other types of lenders who are willing to lend on hotels, suburban office buildings and retail properties.

Research published by J.P. Morgan Securities shows 71 percent of the loans originated for commercial mortgage-backed securities in 2017 were secured by office, lodging or retail properties. Conduits also lend in small markets, where there are virtually no competing non-recourse lenders.

The other reason is a bunch of lenders made big bets at the beginning of the year when the future of conduit lending was in doubt. Those bets were very profitable as spreads came in during the second quarter.

Yes, there is a whole segment of the market that finds conduit lenders morally abhorrent.

Those borrowers look to the comfort of banks or insurance companies to finance their projects, but even borrowers who turn up their nose will still benefit when conduits are stronger. A functioning conduit market supplies liquidity where other lenders will not, and that buoys all of commercial real estate.

Locally, the commercial real estate market is still thriving. New projects are announced weekly, varying in both type and location.

George B. “Casey” Sowers III is working on the construction of the second phase of Winterfield Place, which will include about 200 apartments and 75,000 square feet of commercial space on the south side of Robious Road west of Winterfield Road in Powhatan County.

Sowers and George Emerson, through their Westchester Development Partners entity, are planning to build up to 250 apartments at Westchester Commons in Chesterfield County.

That is in addition to the proposed Midlothian West project of apartments and town homes that BWS Enterprises is trying to get rezoning approval to build just west of Kroger on Midlothian Turnpike.

Blackwood Development also is proposing the Winterfield Crossing mixed-use project on 25 acres north of Midlothian Turnpike and west of Winterfield Road that calls for 250 apartments for people 55 and older and about 100,000 square feet of retail and office.

Next to Winterfield Crossing, CMB Development is proposing a 238-unit luxury apartment complex known as Midlothian Town Center Apartments

John B. Levy & Co. investment banker Andrew Little can be reached at alittle@jblevyco.com.