March 20, 2016

By Andrew Little

Like Joseph, the industrious assistant to Pharaoh in the Bible who hoarded food during seven years of good crops to save Egypt during the ensuing years of drought, many developers are eyeing the economy wondering when the drought is coming.

Well, the first signs may be here. After 6 1⁄2 years of a slowly rising market in commercial real estate, industry data seem to suggest that buyers are taking a breather, albeit not much of one.

According to Moody’s/RCA Commercial Property Price Index, prices in January took their first dip since the middle of 2009. The largest contributor to the overall index drop was pricing on office and industrial properties, which each fell more than 1 percent. Prices on apartment and retail properties, however, continued to gain.

What is interesting about the change in sentiment is that it first showed up for closed sales recorded in January.

Contracts on properties closing that month would have been negotiated some 60 to 90 days earlier, suggesting that buyers were taking their foot off the gas a little earlier than previously thought.

This is surprising because debt markets continued to show strength through the end of the year, and recent struggles in the conduit market should not have significantly impacted sales prices negotiated in fall 2015.

Now that the conduit market is under duress and government bank regulators are starting to scrutinize commercial real estate more, capital is likely to become less available. The one universal fact about commercial real estate is that it’s a capital­intensive business, and when the supply of capital is constrained, pricing adjusts — downward.

According to Commercial Mortgage Alert, commercial mortgage­backed securities issuance year­to­date in 2016 has amounted to $13.6 billion. That is 32 percent less than year­to­date issuance last year.

In 2015, a strong commercial mortgage­backed securities market boasted closings of more than $100 billion, and given the relatively slow start to 2016, that is not likely to be duplicated.

But before every real estate investor runs to their bunkers, they should be encouraged by recent data on corporate bond spreads — from BBB rated to junk bonds. According to data collected by the Federal Reserve of St. Louis, yields on BBB­ rated corporate bonds relative to Treasury yields have fallen more than 0.5 percent since their four­year peak on Feb. 11. Likewise, the same data source shows high­yield BB bond (junk) pricing peaked on Feb. 11 and is down 1.82 percent since.

Why is this important? Because pricing for commercial real estate debt follows pricing for alternative investments, such as corporate and high­yield bonds. Further, pricing for commercial real estate will follow pricing for commercial real estate debt.

In the past month, commercial mortgage rates moved higher, according to the John B. Levy & Co. Mortgage Survey.

Top quality lower­ leverage deals are pricing in the 3.30 percent to 3.75 percent range for 5­ and 10­year deals, respectively.

Conduit loans are pricing closer to 4.95 percent to 5.15 percent for 10–year loans. Meanwhile, 10­ year fixed­rate loans from Fannie Mae and Freddie Mac are pricing in the 4.25 percent to 4.75 percent range, depending on leverage.

Despite volatility in the overall commercial real estate market and a signal that prices may be peaking nationally, the Richmond area continues to see numerous outside investors .

This is particularly true in the multifamily investment arena, where according to data from Real Capital Analytics, several projects have traded recently to investors outside of Richmond.

Cedar Grove Partners III LLC, an investor out of New York, has closed on a string of multifamily deals located along Chamberlayne Avenue. The most recent was a 216­unit project formerly known as Chamberlayne Gardens, which closed in January for about $35,800 per unit.

Several other multifamily projects are currently for sale and in the process of being marketed to investors. Given the cheap, relatively stable money available , this trend is expected to continue.