Commercial Mortgages: Commercial real estate remains strong even with talk of a possible recession

RICHMOND TIMES-DISPATCH

by Andrew Little, Special CorrespondentLike the lyrics from Elton John’s 1983 hit “I’m Still Standing,” the economy has sustained multiple headline-grabbing shocks from around the world for the past few years but continues to chug along.Yet the crescendo of recession talk seems to be growing louder and louder in recent weeks.When all the noise is turned down, however, the only tangible evidence of a slowdown showing up in the U.S. so far relates to manufacturing where the Purchasing Managers’ Index for September showed the steepest month of contraction in the manufacturing sector since June 2009.In commercial real estate, a slowdown in manufacturing could lead to fewer needs for merchandise to be stocked in warehouses. But there is no sign of industrial property weakness in the U.S.

For instance, the largest private real estate transaction in history occurred in the past month with Blackstone Group acquiring the U.S. industrial warehouse properties of Singapore-based Global Logistics Properties in an $18.7 billion deal.Industrial property demand over the past two decades is almost entirely related to e-commerce distribution and logistics rather than to manufacturing.The talk about recession has investors on edge, and the low PMI readings are keeping anxiety high.The silver lining for commercial real estate owners is that recessionary fears continue to keep U.S. Treasury yields at an all-time low.

That has supported two advantages. The first is low interest rates.Commercial mortgage rates for 5- and 10-year loans range from 3.15% to 3.35% for lower leverage transactions, according to the John B. Levy & Co. National Mortgage Survey. Higher leverage 10-year conduit loans are now pricing in the 3.50% to 3.75% range.While not quite as aggressively priced, bank loans, which offer much more flexibility than conduit or permanent insurance company-backed loans, are ranging from 3.75% to 4.50%, depending on the borrower and property.The second benefit to the continuing din of recessionary fears for commercial real estate owners is that low Treasuries keep cap rates low, which translates to higher values.

In most top-tier markets, the lower Treasury yield has worked to stabilize cap rates so that they are mostly unchanged from a year ago.In smaller markets, like Richmond, cap rate compression is still occurring, and that can be largely attributed to out-of-town buyers gobbling up the relatively high returns here compared to larger cities.A recent report from commercial real estate brokerage Cushman & Wakefield | Thalhimer on industrial and office properties in the Richmond area shows that perhaps the out-of-town buyers are paying lower cap rates for good reason.

The overall vacancy in the industrial market averages 2.7%, according to the report.This indicates that net operating income growth can be anticipated as the demand supply imbalance can help push rents higher.A similar finding appears in the office market report for Richmond.The 53.2 million square feet of office space in the region has an overall vacancy of 5.8%. This low vacancy and lack of abundant supply should eventually translate to higher net operating income growth in the office sector.