Investors hope real estate is able to avoid downturn

January turned out to be a very active month for commercial real-estate finance.

Fears about overbuilt, underoccupied, overleveraged and overpriced markets have given way to jubilation on the part of many investors who hope real estate will avoid a downturn.

Although it would be hard to argue that real estate has not been affected by the economy, commercial mortgages have enjoyed a fantastic run lately. More specifically, real-estate debt traded as commercial mortgage-backed securities (known as CMBS) is now pricing as tight to U.S. Treasuries as it ever has.

The tightness in CMBS pricing has allowed lenders to offer better rates to borrowers. Rates now range from 4.65 percent to 5.55 percent for 5- and 10-year mortgages, respectively, according to the Barron's/John B. Levy & Co. National Survey.

To put this type of pricing into perspective, we looked at Barron's/Levy data collected during the past 20-plus years. Although current pricing is not at its lowest point (which occurred briefly last summer), from a long-term look, it is quite good. Since January 1983 the average 10-year mortgage rate has been 8.57 percent, a full three percentage points above current rates.

What's interesting is the combination of a low-interest-rate environment and aggressive competition among lenders and investors. As commercial mortgages continued to perform well through the economic downturn, lenders have felt more pressure to add to their portfolios.

The Mortgage Bankers Association recently held its annual convention in Orlando, Fla. This year the overwhelming consensus among commercial lenders attending the event was:

• They had pressure to put out more money this year than they did in 2003, and • They had no idea how they were going to achieve their goals.

One way for lenders to compete in this frenzied market is to come up with creative programs that meet borrowers' needs. Several lenders have come up with construction-permanent loan programs for properties occupied by credit tenants. Of particular interest was the program that allows a loan to float at bank rates during construction but locks in the permanent rate today for the period the tenant takes occupancy and pays rent.

Along these same lines are "forward" pricing programs. These programs allow a borrower to lock in today's low interest rates for a loan that begins in six to 18 months. While these programs have always been the domain of insurance companies and pension funds, Wall Street conduits now have the ability to allow "forward" pricing for the first time since their inception in the early 1990s.

Both programs are in response to borrowers' needs. Nonetheless, they were created to allow lenders to gain market share getting above-average pricing.

Similarly, real estate investors are searching for above-average returns in a competitive market. The Carlyle Group, a Washington-based global private-equity investor, recently set its sights on Richmond to gain above average returns in real estate. Through Brownfield Capital based in Denver, the group is moving forward with East West Partners with a plan that would allow a significant amount of development to occur east of Shockoe Bottom and Church Hill near the former Fulton Gas Works site.

Carlyle, which has raised more than $1 billion to invest in real estate since 1997, generally sees opportunity where others aren't looking. While the plans are in their infancy, the partners involved make the project instantly credible and will only add to the growing sentiment that downtown Richmond is abuzz with opportunity.

Andrew Little is an investment banker with John B. Levy & Company, Inc.

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