“Canary in a Coalmine” was one of the lesserplayed songs on The Police’s 1980 album, “Zenyatta Mondatta.”The song, about a person living nervously, referred to the miner’s tactic of bringing a canary into a coal mine to act as an early detection signal when poisonous gases were present that could prove deadly.Today, while everything appears sunny in commercial real estate, it’s hard to pay attention to early warning signs.Kroll Bond Rating Agency, however, acted like the canary in a coal mine recently by releasing a credit analysis on banks that effectively indicates that the last time things were this good it was a sign that things were bad.The report indicates “asset valuations have recovered to such an extent that key credit indicators in the banking sector are once again generating warning signs of future credit losses.”
As it relates to commercial real estate, the report points out that onethird of the loans conduits are selling as commercial mortgagebacked securities have a 110 percent loantovalue ratio, according to Kroll’s valuations.Recent pricing of commercial mortgagebacked securities, however, may indicate investors are paying attention.Price widening that buffeted the market in the summer months has not reversed. The latest deals that have priced are close to the highs for the year.Higher pricing along with a spike in U.S. Treasury yields pushed commercial mortgage rates up in the past month, according to the John B. Levy & Co. Mortgage Survey.
Top rated 5 and 10 year loans now range from 3.5 percent to 4.15 percent, respectively. Full leverage 10 year conduit loans, however, are pricing closer to 4.9 percent.Another indication or early warning sign was tripped late last month when Equity Residential agreed to sell 72 apartment communities to Starwood Capital Group in a $5.365 billion deal.While the 23,262 unit portfolio represents only a portion of the apartment communities that Equity Residential owns, company Chairman Sam Zell has a knack for timely decision making.In 2007, Equity Office Properties Trust, another real estate investment trust that Zell started, was sold to Blackstone Group LP for $23 billion. The deal came to symbolize the boom and bust in the market that came to a screeching halt later that year.
For all the handwringing related to timing the commercial real estate cycle, most real estate professionals look at current valuations in the major markets and agree that valuations seem to be peaking. That same group also would agree that the economy has a long way to go before it overheats.Those two sentiments are hard to reconcile and are at the heart of the conundrum for the Federal Reserve.The Fed’s job is to stop markets from overheating by increasing interest rates at the appropriate time. Very few signs show markets are overheating, but with rates at near zero for so long generally leads to asset bubbles or overpriced assets.
While an argument could be made that commercial real estate is priced aggressively, most real estate economists think these prices are sustainable. Many believe more growth in property cash flows is coming as the economy grows and cap rates will remain steady despite rising interest rates.The Richmond area has plenty of evidence of a healthy investment sales market, but there are very few signs of the market overheating. Activity has been brisk in virtually all property types, but market activity doesn’t necessarily translate to a bubble.In fact, few apartment projects have sold below a 6 percent cap rate in Richmond, yet the average cap rate across the Equity Residential portfolio that Starwood is purchasing is 5.5 percent, according to the seller. Compared with many of the hotter markets, the 5.5 percent cap rate seems relatively high.Office properties also are a hot commodity in major markets, but recent office property sales and price talk on assets for sale in the Richmond area are still reasonable and nowhere close to replacement cost. So commercial real estate players locally are ready for the cycle to continue its upswing.
