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Investors continue to push borrowed money into U.S. commercial real estate (CRE), making for a positive outlook for capital markets in 2014. Experts say credit performance is improving and lending restrictions are likely to loosen, which means investors will likely not waver in their borrowing habits despite the prospect of rising interest rates in the coming year. Short-term gains are still marginal, but many investors are still willing to snap up the current fixed rates for long-term investments and there are plenty of banks, life companies and CMBS lenders at the ready. For more on this continue reading the following article from National Real Estate Investor.

Expectations for rising interest rates in the coming year don’t appear to be stemming the tide of capital flowing to commercial real estate.

This year has shaped out to be the best year for mortgage originations since the downturn. The total volume of commercial and multifamily debt outstanding in the U.S. at the end of second quarter was at $3.107 trillion, which represents a $17.3 billion increase during the first half of the year, according to data from the Federal Reserve. That momentum is likely to carry over into 2014 with credit standards expected to loosen further as credit performance continues to improve, according to analysts from Reis, a New York-based research firm.

“It has been a terrific year in actual financing activity and rates are still compelling,” says Ed Padilla, CEO of Minneapolis-based NorthMarq Capital. For the most part, the commercial real estate market has absorbed the interest rate hike that occurred earlier this summer.“We thought it would be extremely painful and slow for the market to look at a 100 basis point increase,” says Padilla. “But, in reality, the large majority of real estate investors still believe that if they can lock in a 10-year fixed rate starting with a four--that is still an asset that will ride along with their property for years to come.” 

Currently, the 10-year Treasury has been hovering at about 2.70 to 2.75 percent, which is up about 100 basis points compared to the rate of 1.70 percent at the end of April.

Although interest rates are poised to move even higher in 2014, borrowers will likely continue to have access to capital. “If anyone tries to convince themselves that (interest rates) are not moving higher, they’re fooling themselves,” says Wesley C. Boatwright, managing director, Capital Markets Group | Real Estate Investment Banking for Jones Lang LaSalle in Washington, D.C. Federal reserve policy has kept both long- and short-term interest rates at historically low levels, even taking the recent rise into consideration.

For those borrowers that are looking for short-term money, rates are still at 2 percent or lower. “You can still borrow 175 to 180 basis points over LIBOR,” says Boatwright. As of early December, the 1-month LIBOR was at 0.16 percent. So borrowers can still access short-term, floating rate financing at about 2 percent. “That is still positive leverage even if you are buying assets at a 4.5 cap,” he says.

“The Fed controls the short term and they are absolutely adamant that they are not going to raise the short-term rate higher, because they believe that the economy is in a slow, fragile recovery,” adds Padilla. The long-term rates are controlled more by trading and it seems clear that the Federal Reserve will reduce its $80 billion per month appetite to buy bonds. The 10-year Treasury yield will rise when that tapering occurs, which is expected to begin in first or second quarter. “There are many people, myself included, who believe the 10-year Treasury will go above 3 percent in 2014,” he says.

If spreads remain constant, interest rates on loans will rise in concert with Treasury yields. However, for a 65 to 75 percent loan-to-value loan, rates on fixed-rate permanent loans are currently between 4.5 to 4.8 percent. The general marketplace opinion is that long-term rates will rise above 5 percent as 10-year Treasury rates trend higher, says Padilla.

Capital sources

Banks, life companies and CMBS lenders are expected to continue to serve as key sources of commercial real estate capital in 2014. The CMBS market has come roaring back with U.S. issuance approaching $90 billion in U.S. for 2013, according to Commercial Mortgage Alert. That volume is nearly double the $45.8 billion in issuance that occurred last year and also represents a record high level since the financial crisis.

There has been a lot of discussion about whether a deluge of CMBS maturities beginning in 2014 will trigger bigger financing problems in the coming years. “We are now starting to see that the CMBS market has come back quite strong, and will now likely be able to deal with the majority of its own maturing loans,” says Padilla.

In addition, there appears to be more groups stepping into the mezzanine niche to help shore up any financing gaps – and generate higher yields in the process. JLL currently tracks 40 to 50 different bridge lending groups that do higher leverage loans and loans on buildings that are in transition or have greater risk, such as higher vacancy. “I think you are going to see more of those groups forming in anticipation of this wave of maturities,” adds Boatwright.

Certainly, financing is not back to the levels that the market was experiencing in the run-up prior to 2007. Lenders are erring on the side of caution with more modest loan-to-value ratios and underwriting standards. Multifamily is the exception to that. The availability of capital for multifamily is even higher than what existed at the peak of the market in 2005 and 2006.

This article was republished with permission from National Real Estate Investor.