Rates rise as investor sentiment turns positive

On the first of October, the yield on the 10-year Treasury note stood at about 3.95 percent. A little more than a month later, the yield on the 10-year Treasury now ranges from 4.40 percent to 4.45 percent, or 45 to 50 basis points higher.

As a result, commercial mortgage rates have gone up and now range from 5.10 percent to 6 percent for 5- and 10-year terms, according to the Barron's/John B. Levy & Co. National Survey.

The move in rates hinged on investor sentiment which, based on economic reports released earlier this month, has turned positive.

In particular, talk of a "jobless recovery" virtually disappeared with the Nov. 7 release of employment data for October. According to the report, 126,000 jobs were added to nonfarm payrolls, more than twice the consensus estimate.

A week earlier, the Bureau of Economic Analysis released information that indicated gross domestic product had increased at an annual rate of 7.2 percent in the third quarter, the highest rate of growth since 1984.

Seen as good news

Excepting Democratic presidential hopefuls, these reports are fantastically good news for most people, especially those in commercial real estate.

For several years now, commercial real estate has been riding high when compared to the stock market and corporate bonds.

Indeed, JP Morgan recently published an interesting analysis comparing defaults on commercial mortgage-backed securities (known by the acronym CMBS) to defaults on corporate bonds for 2002.

The results show that CMBS outperformed corporate bonds during a stressful time frame. Overall defaults in CMBS stood at a relatively paltry 1.07 percent, while A-rated corporate bonds had a default rate of 3.62 percent, and Baa-rated corporate bonds had a default rate of 3.72 percent.

Despite all the positive reports, most real-estate people have been looking over their shoulders wondering when bad news was going to gush out. The fact that bad news has not come and the economy has revved up is yet another boost to the sector.

Reminder of risk

Just when investors were beginning to view commercial mortgages through a set of rose-colored glasses, there was a reminder that real estate carries risk after all.

In late October, Market Center, a 770,000-square-foot, twin-tower office property, was purchased for $79.5 million, or some $103 per square foot. The downtown complex, formerly Chevron Corp.'s headquarters, had been mortgaged and sold as part of a Morgan Stanley securitization in 2000.

At the time of the securitization, most real-estate people still had a frothy view of San Francisco and, in fact, the Moody's presale report indicated that the building was worth $242 million. The $162.5 million loss in value on one building resulted in $18 million in BBB-rated bonds suffering a total loss.

Here in Richmond, the value swings are not quite as dramatic, but one investor took some risk and received a huge reward in connection with the old Signet Corp. headquarters building at Eighth and Main streets downtown.

Washington, D.C.-based Douglas Development Corp. purchased the building in the third quarter of last year for $4.25 million, or a tad over $25 per square foot.

Although many local players gagged at the purchase price, the out-of-town investor, represented locally by Ned Roberts of Advantis, recently signed the Virginia Department of Social Services to a 160,000-square-foot lease to occupy the building.

This lease, certainly one of the largest signed in the city's recent history, makes the $4.25 million price tag seem bargain-basement cheap.

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

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