Capital markets regulation is at the top of US commercial real estate debt specialists’ minds as we enter 2016.
As part of the long-awaited Dodd-Frank Act’s implementation, federal agencies voted last year for new risk retention rules which many fear will trip up the CMBS market. Issuers of CMBS will be required to hold a larger portion of their deals on balance sheet, likely to result in increasing costs.
Market players would do well to remember, however, that the initial Dodd-Frank proposals in 2011 were far more draconian, including a proposal that required sponsors to absorb losses before the most junior tranches.
The US CMBS market has staged an impressive recovery in recent years. In September, Commercial Mortgage Alert reported that CMBS issuance in the US for the first nine months of the year had topped $77 billion, closing in on 2014’s full-year total of $94 billion. However the impact of risk retention regulation, in addition to rising interest rates and falls in commodity and bond prices, will create uncertainty in the market in the first part of 2016, observers predicted. A choppy end to the year saw the volume of new issuance fall off.
The Fed’s 0.25 percent rate rise, meanwhile, is not expected to have a huge impact on the commercial real estate market. Some optimists said that the Fed has more room for rate rises before there is any real pressure on cap rates. The capital markets had already priced in the much-anticipated rate rise, others added.
Generally, the outlook for US commercial real estate is bullish, if slightly tempered. A three-year economic forecast by the Urban Land Institute, published in September, said that the consensus forecast was slightly less bullish in its outlook since the it previously canvassed the market in April 2015, but it predicted three more years of favourable real estate conditions.
While 2015 began with a wave of optimism in the market, the atmosphere in the sector as 2016 approaches seems very different, says Matthew Cohen, a principal with lender Mesa West Capital responsible for capital markets.
“The real estate capital markets roared into 2015 with a record amount of public and private capital looking for a home in real estate. But the concerns over rising interest rates, increasing capital regulations and an historic collapse in commodity and bond prices has created some level of uncertainty as we enter 2016.
“Consequently, the first half of the year will be an adjustment period as the junk bond market shakes itself out and we adjust to the first interest rate hike almost a decade. I believe activity will pick up as the year goes on proving that the US real estate markets continue to be the safest long-term home for investment capital in an unstable global economic environment.”
The impact of increased regulation is likely to be felt across the US CMBS market, warned Terence F Baydala, managing director – originations, for Pembrook Capital Management.
“In 2015, there were no major surprises and most markets continued to show relatively balanced fundamentals. Millennials and Baby Boomers continue to move towards the “urban core” and certain CBDs with plenty of lifestyle choices to offer have seen significant redevelopment activity, particularly with the conversion of antiquated office to multifamily or hospitality.
“2016 – With new risk retention rules coming into play, watch how the CMBS market behaves in the coming months, especially as the refinance wave continues. Interest rate movements will likely be to the upside particularly in the floating rate market which could adversely affect value-add plays. Watch for the first cracks in the condo market appearing. We expect to start seeing condo inventory finance opportunities as the year progresses.”
“2015 was one of the strongest transitional lending environments given the tame fundamentals, technical volatility and discipline enforced by the regulatory environment. The transitional capital supply/demand imbalance allowed transitional lenders to be selective and disciplined.
“In 2016, [there will be] continued strong RE fundamentals but with the caution of delicate and continually illiquid capital markets given added regulation which may affect relative value in the transitional lending space. Coupled with that, the continued chase for yield and competitive equity transaction environment will push sponsors to focus on value-add situations which traditional banking channels cannot provide capital for as in the past.”
JLL senior vice-president Brett Rosenberg warned that liquidity and pricing in the debt capital markets could be affected by a variety of factors.
“While fundamentals remain steady, the widening of credit spreads in alternative asset classes, coupled with looming CMBS maturities and new regulatory requirements for CMBS issuers, there is potential for some disruption for debt capital liquidity and pricing in the second half of 2016. Borrowers should think about timing of bringing new deals to the market to ensure best execution.”