Fortunes of war had effect on interest rates

Acting like strung out gamblers at the horse track scrambling to the betting window before post time, borrowers piled on commercial-mortgage debt during the first quarter of 2003.

Essentially betting that rates are moving upward, they were trying to slide transactions in before the low-rate window closes.

Who can blame them? Bumping along at 45-year lows, interest rates are between 4.75 and 5.75 percent for 5- and 10-year commercial mortgages, according to the Barron's/Levy National Mortgage Survey.

There were brief moments during the past month that rates were as much as 0.4 percent lower, but trying to find the perfect time to lock in rates has been a little like playing roulette.

Volatility relates directly to the war in Iraq, and some investors have been referring to it as the "CNN effect." As the boiling pot of war-related pressures overflowed and bombs started dropping, investors initially reacted with a flourish.

Money flowed out of U.S. Treasuries and into the stock market. This sector shift caused the yield on the 10-year Treasury to jump violently, taking commercial rates with it.

When the negative news started outweighing the positive news, investors ran back to Treasuries and caused the yield to lurch back down. Now, with more encouraging news, rates are drifting back up.

While the war may have created a sense of urgency and forced investors to focus on decision making, the effects of a lingering recession will play a more prominent role for rate movement in the coming months.

About 465,000 jobs have disappeared in the past two months, and the Federal Reserve is mulling its options. With fewer weapons to fight a recession because rates are already so low, the Fed may turn to buying long-term Treasuries. Such a move would tend to keep commercial-mortgage rates in check.

Hotels, which are affected immediately by economic trends, had a horrible first quarter, and delinquencies in commercial-mortgage-backed securities involving hotels ended March at 6.72 percent, up from 4.6 percent of total volume in November.

Overall, real-estate loan delinquencies have remained stable, even in the face of deteriorating real-estate fundamentals. However, recently published research from Merrill Lynch and J.P. Morgan indicates that, despite the appearance of stability, the strength of real estate credit is slipping.

Richmond-based Cornerstone Realty Income Trust Inc., a publicly traded real estate investment trust that specializes in operating apartment communities, mirrored a national trend of deteriorating fundamentals at the property level.

According to the recently released 10-K for 2002, same-community property operating income fell 9 percent from 2001 to 2002. The results were certainly reflective of weakness in several key markets for the REIT, including Atlanta, Charlotte, Dallas and Raleigh.

According to J.P. Morgan, apartment income on a nationwide basis fell 9 percent last year. Despite the weak showing, delinquencies for apartment loans have changed very little in the past 18 months, hovering below 1 percent at 0.93 percent, based on the volume of delinquent loans compared to the total loans outstanding.

J.P. Morgan attributes the continued low delinquency rate to the fact that investors are still paying top dollar for apartment communities.

Andrew Little is an investment banker at John B. Levy & Co.

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