COVER STORY, JANUARY 2007

CLEAR HORIZON
Financial forecast sees clear skies for 2007.
Daniel Beaird

The Southeast remains one of the best lending environments in the country due to its population growth and its strong employment trend during the past few years. Lenders across the region maintain that the horizon is clear for another good lending year in 2007. In fact, lenders like the environment across almost all property types. That conducive lending environment has been built on lenders becoming more creative as more lenders came into 2006 with the ability to control the capital stack. Therefore, borrowers were offered much more flexibility in loan products; and the demand for  those creative loan products should continue into this year as acquisition activity remains high on all property types across the region.

As more people move to the Southeast and more companies relocate their businesses to the region, commercial real estate properties continue to be bought and sold at a fast pace as institutional investors, public real estate investment trusts (REITs) and equity funds remain the primary owners and purchasers in today’s market. Due to the fast pace nature of the lending environment, underwriting standards continue to be aggressive. “Clearly, there is more debt capital chasing real estate transactions and more innovative and aggressive debt products today than a year ago,” says Martin Fayer, senior vice president with Johnson Capital’s Washington, D.C., office. “Assuming new development remains in check with demand, the real estate markets should continue to prosper.”

Another favorable prediction for the Southeastern lending environment this year is little to no change in interest rates. “I don’t think interest rates are going to change materially in any direction, so its full steam ahead in 2007,” says Faron Thompson, managing director with Primary Capital’s Atlanta office. “This year will be a great time to do some buying and selling because construction continues to be in check in most markets, so the demand side will continue to deliver some performing properties.”

If there is any movement at all it may come at the first of the year. “There are some indications that the Fed may reduce the Fed Fund rate in the first or second quarter of this year,” says Larry Curry, director with Cohen Financial’s Tampa, Florida, office. “If that happens, short-term rates will come down a bit, but there won’t be any pressure on long-term rates.”

Because the Fed has left short-term rates untouched for awhile, an inverted yield curve has been created between LIBOR and the 10-year treasury. “It will be interesting to see what happens if we go back to a normal dynamic in which LIBOR is much lower than the 10-year treasury,” Fayer says. “If that happens, there may be a shift in financing to floating rates again because there has been very limited floating rate debt. Borrowers have been using fixed-rate products for debt to accommodate some of their short-term needs because it is cheaper.”

The past year witnessed an abundance of debt capital providers trying to change deals or secure deals in the capital markets. “There has been a lot of innovation in those markets and the rates on those loans, or the credit spreads, have come down dramatically,” Fayer says. “Lenders are willing to take the same amount of risk for less spread or lower rates, which is an interesting phenomenon.”

As deals are there to be made, the fundamentals of all properties have improved in the past year. “An investor can buy an existing product, make some significant upgrades and realize a good return on that investment because new construction sites are hard to come by in the region unless an investor buys an existing property and tears it down, which can be cost prohibitive,” Thompson says. “Lenders that can put renovation and bridge packages together and take that up the capital stack are going to be well positioned in 2007.”

While properties are performing favorably in the Southeast compared to the rest of the country, the bloom has come off the multifamily sector due to the condominium conversion craze coming to a halt in 2005. While the multifamily sector tries to bounce back, the retail, office and industrial sectors are all performing well from a lender’s perspective in the Southeast. “Some of our multifamily investors sold their multifamily portfolio to invest in retail,” Thompson says. “I wouldn’t characterize that as a market wide phenomenon, but it proves the success of the retail market.”

“Each lender has a different appetite, but in general, all property types are firing on all cylinders and I don’t see one particular property type that is in more demand than another,” Fayer says.

Even hospitality performed well last year. “Hospitality is a feast or famine kind of business, its either doing great and people love it, or its performing horribly and people hate it,” Thompson says. “The past year was a great one for hospitality and barring some catastrophic event in 2007, it’s going to continue to perform well.”

And those multifamily investors that sold their portfolio? Lenders think they will be back in the multifamily game before too long. “Now that the conversion wave is sort of behind us, sellers are back selling properties on fundamentals, and not on inflated prices for condominium converters,” Thompson says.

“The cooling of the conversion craze helped the multifamily market in 2005 because it reduced inventory of available apartments, made the markets tighter and made concessions go away,” Curry says. “In 2006, there was some concern about condominiums coming back on the market as rentals, but there won’t be any substantial reduction because of Florida’s strong employment numbers.”

The only problem remaining for the multifamily market is the uncertainty of the insurance business in Florida after the destructive hurricane seasons of 2004 and 2005. “The multifamily market can overcome those two hurricane seasons because, to be honest, people have short-term memories,” Thompson says.

Overall, values will continue to be aggressive heading into this year and borrowers will be seeking creative ways to increase returns with their debt. “The debt markets will continue to innovate and provide solutions to borrowers attempting to attain return hurdles in the highly competitive real estate market,” Fayer says.


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