MARKET INSIGHTS
November 20, 2016

By Andrew Little

For the first time in history, a commercial real estate developer will lead the free world, but President­elect Donald Trump’s tweets are probably more to blame for post­ election market volatility than his occupation.

The most immediate impact felt by commercial real estate was a 0.40 percent run up in the 10­year Treasury on the expectation of inflation.

While it’s too early to gauge which policy changes could happen and how those may impact commercial real estate, that didn’t stop industry participants from reacting to Trump’s upset victory.

One area of speculation revolves around the hope that Trump will overhaul Dodd­Frank regulations that was passed after the financial crisis. A particular difficult piece of that reform has roiled the commercial mortgage­backed securities market this year making conduit lenders less competitive on pricing and more limited in their underwriting.

The so­called “risk retention rule” takes effect Dec. 24 and requires lenders in the asset­backed financing world (which includes commercial mortgage­backed securities lenders) to hold a portion of the loans they originate on their books for a minimum of 5 years.

Since conduit lenders make a living by bundling mortgages and selling all of the risk to bond­buyers through rated tranches, this change is significant.

So far, the impact has been an increase in pricing that ranges from 0.15 percent to 0.30 percent, but recent reports are suggesting that the changes will create a tougher environment for smaller CMBS lenders, who will have to pay larger players to absorb the risk retention requirement.

This is likely to push out pricing an additional 0.15 percent to 0.20 percent on loans originated by lenders who don’t have their own distribution desks.

Bethesda, Md.­-based Walker Dunlop Inc., one of the nation’s top commercial real estate finance companies, is an example of a smaller player that shut down its conduit operations a few weeks ago after exploring ways to navigate the new regulatory terrain.

Trump has been a critic of over­regulating, but it is unlikely that this aspect of Dodd­Frank will be changed anytime soon.

The basic premise is that lenders should own risk they are underwriting versus selling it off to others. At its core, risk retention is hard to argue with.

The other area of post­election speculation relates to the fate of Fannie Mae and Freddie Mac, the two giant, government ­owned lenders that support a huge percentage of home loans in the country as well as 34.3 percent of all multifamily loans, according to second quarter Federal Reserve data.

Trump has said very little specifically about Fannie and Freddie. However, one of the lenders’ loudest critics, House Financial Services Committee Chairman Jeb Hensarling, R­Texas, was floated as a potential appointee to run the Treasury Department. Hensarling drafted legislation five years ago to dismantle Fannie and Freddie to make the secondary market for mortgages entirely private.

Industry pundits can guess at what’s next, but the biggest potential disruption to commercial real estate transactions relates almost entirely to interest rates, which are not headed in the right direction.

On Election Day, rates stood about where they were last month with the 10­year Treasury hovering around 1.85 percent and 10­year conservative loans priced at about 3.65 percent range. A week later, rates are up approximately 0.40 percent and now range from 3.5 percent to 4 percent for the best 5­ and 10­year loans, respectively.

Similarly, conduit pricing has ballooned out in response to widening of the Treasury yield, but spreads have remained stable. The 10­year commercial mortgage­backed securities loans are pricing in the 4.75 percent to 5 percent range. Bank loans remain somewhat stable and 5­year money remains priced in the 3.5 percent to 4 percent range.

Despite extremely low rates, anytime a sudden increase like this occurs, it puts transactions on hold.
It is hard to imagine not investing in a deal because the rate is 4 percent versus 3.5 percent, but the typical buyer will be somewhat shell­shocked while rates stabilize.

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In the Richmond region, a few large deals are making their way through due diligence and closing process and shouldn’t be impacted by the brief run up in the bond market.

For instance, the James Center office complex in downtown Richmond is under contract, but the potential buyer is looking to lease up the vacant space to add value which would make the investment less interest­ rate sensitive.

The three­ building complex off East Cary Street was put on the market in September. The complex is owned by LNR Partners LLC, a Miami Beach­based commercial mortgage special servicer that took control of the property in March when the former New York­based owner turned over the keys to the lender, providing a deed in lieu of a foreclosure.

Also, several large office parks in the region are under contract and moving toward closing and shouldn’t be impacted significantly.

North Run Business Park is under contract and should close prior to year­end, industry sources say. Several other sizable transactions also are nearing completion.