September 18, 2016

By Andrew Little

The Portland, Ore.-­based alternative rock band Joseph has a hit song, “White Flag,” that speaks to never giving up despite “noises closing in from all sides ... warning all the ways to die.”

While the band most certainly isn’t talking about the economy, the sister trio’s eerily siren­like voices are singing the song of real estate investors today.

Commentators are clamoring about the market being past its peak and how we are in the late innings, but commercial real estate investors are ignoring the naysayers and piling money into new deals.

While it is hard to conclude that pricing is in bubble territory,recent research shows that pricing and sales volumes are definitely at peak levels. The average pricing on every asset class nationally is above its prior peak — the prior peak pricing occurred prior to the recession — according to the latest Moody’s/RCA Commercial Property Price Indices released earlier this month.

The data show volumes also are at peak levels and on par with 2015, but well ahead of pre­recession levels.
Of course, apartments lead the class with an astounding 48 percent average price increase since the last peak, which was December 2007.

That trend is continuing into the second part of this year with average apartment pricing up 14 percent the past 12 months — the highest increase of all asset classes.

When digging into the smaller markets, there is a little more to the story. For instance, average suburban office prices in non­major markets are still 15.4 percent lower than their pre­recession peaks, according to the Moody’s/RCA report.

Apartment pricing in non­major markets, however, is still quite strong and up some 34 percent since its last peak.

There are a lot of reasons why investment pricing increases and demand for apartments has outpaced suburban office properties, but a leading cause is the availability of cheap debt from Fannie Mae and Freddie Mac, which has kept apartments strong in most markets.

Debt for suburban office properties, on the other hand, is highly dependent on the strength of the conduit market and that market has been very inconsistent since the recession. Today, it is fairly stable and providing a window of opportunity for investors.

Overall, pricing for loans continues to be aggressive, according to the John B. Levy & Co.’s national mortgage survey. The most conservative loans of 5­ to 10­years in term are pricing in the 3.25 percent to 3.50 percent range, and higher leverage conduit loans are pricing in the 3.95 percent to 4.25 percent range for 10­years.

Conduits don’t tend to differentiate pricing between apartments and suburban office, so investors are taking advantage of low interest rates and high investment yields on suburban office, and that is creating more activity in the asset class.

If sales activity for office in Richmond is a proxy for other non­major markets, pricing should be returning to peak levels soon.

Several large office transactions are on the market and in the process of getting sold. Assuming the markets don’t get too volatile, this trend should continue.

Much of the volatility in the market relates to what is going on with shorter­term money, but chatter and speculation about the Federal Funds Rate seems to impact longer term rates more than variable rates.

Richmond Fed President Jeffrey M. Lacker recently gave a speech indicating that technical analysis used in the past by the Federal Open Market Committee, which makes the key decisions about interest rates, shows that the Federal Funds Rate target should be higher — somewhere between 1.50 percent and 3.30 percent compared with today’s target of 0.25 percent to 0.5 percent.

The Fed meets this week and will announce Wednesday whether to raise rates or to hold off until later this year. The Federal Reserve boosted interest rates in December for the first time in nearly a decade, raising the rate by a quarter­point to a range of 0.25 to 0.5 percent. It had been at a record low near zero since late 2008.

But while the hawks on monetary policy are pushing for a rate rise, a larger gathering of doves are calling for a more measured approach.

That, in combination with low rates around the globe, is sure to keep interest rates relatively low, and commercial and multifamily real estate benefit with cheap money.

In short, it is a good time to be a borrower.