July 17, 2016

By Andrew Little

Elvis Costello most certainly wasn’t talking about what global governments are paying investors to hold their debt in his 1977 hit song “Less Than Zero,” but in this post­Brexit world, investors are hungry for a safe place to stash capital, which creates some interesting dynamics.

More than $13 trillion of negative yielding in sovereign global debt has been sold, according to a recent Wall Street Journal study. That amounts to about 22 percent of all global public debt outstanding.

The primary cause is fear and uncertainty across global markets. The U.S. economy, while interconnected globally, is relatively strong, with growing employment.

For commercial real estate investors, the rare combination of an improving employment picture with low yielding Treasuries is a bonanza.

In fact, as investors search for secure places to earn a decent return, commercial real estate keeps hitting the radar.

A lower yielding U.S. Treasury means lower interest rates for commercial real estate. Rates on 5­ and 10­ year commercial mortgages are at historic lows and range from 2.85 percent to 3.25 percent, respectively, for the best loans, according to the John B. Levy & Co. National Mortgage Survey.

Banks continue to grapple for deals, and many are pricing 5­ and 7­year deals in the 3.25 percent to 3.75 percent fixed­rate range with floating rate loans going much lower.

Conduits, meanwhile, are back and are hungry for new business.

The search for yield has helped commercial mortgage­backed securities make a huge comeback from earlier in the year when high pricing, uncertainty and volatility staggered conduit lenders.

There is uncertainty regarding new regulations that will be implemented at the end of the year for those B­ piece buyers, or those who generally buy B­rated and or lower bond classes. The changes in the rules still cast a shadow over the market, creating volatility.

Global instability, however, is making the commercial mortgage ­backed securities sector look somewhat stable.
What brings borrowers back to commercial mortgage­ backed securities is a short memory about prior experiences and attractive rates.

Today, new conduit loans are pricing in the 4 percent to 4.5 percent range for 10­year deals, depending on the size and cash flow of the property.

As many insurance companies have reached their goals or are far on their way to doing so for 2016, they are looking more and more conservatively at deals. The combination of great pricing and lack of other non­ recourse sources is making conduits attractive again.

Of course, multifamily apartment loans continue to be the domain of government­ sponsored enterprises Fannie Mae and Freddie Mac. Pricing on full 10­year loans is in the 4 percent range with lower leverage deals pricing 3.5 percent to 3.75 percent.

Multifamily loans have been aggressively sought after by all lenders for some time and, according to local investment sales brokers, pricing for properties in the Richmond area is as aggressive as it has ever been.
Recent sales of 30­-year-­old properties with significant need for lipstick confirm the observation. It is now typical to see older properties in Richmond where units are in need of upgrading to sell for a cap rate below 6 percent.

For investors coming from outside the area, that seems like a real bargain and in light of the 10­ year Treasury yield, maybe it is.

With the 10­ year Treasury at 1.5 percent, a property purchased at a 5.5 percent cap rate would theoretically offer an investor a return that is 4 percent over the “risk­free” investment yield.

On older properties, the prospect of adding value through upgrading units and exiting at a profit is what is attracting huge waves of capital seeking to earn a mid­teens return on investment.

The theoretical world of earning mid­teens on value­added investments and the real world have proved to be about the same in the multifamily space for a long time, so there is scant reason to second­guess it now, especially in an environment where one­fifth of the world’s debt is yielding less than zero.