Manhattan CRE Debt Investors are Sitting Pretty in 2018
Historical Market Performance Points to Upcoming 'Refinancing Wave'
Manhattan commercial real estate investors on both sides of the aisle - debt and equity - have taken note of asset performance in 2017... and a quorum of leading capital markets experts agree: debt investors are well-positioned in 2018.
"I think the debt business is a great place for leaders and investors to be. People who have gotten into the debt business are doing very well at this point," Cushman & Wakefield’s Bob Knakal intoned at a January 2017 New York City Capital Markets Outlook presentation.
"Timing wise, to be a debt fund, you are positioned favorably," adds Paul McCormick, senior vice president of investment sales at Ariel Property Advisors. "Traditional lenders are less inclined to be aggressive when interest rates are creeping up."
"It’s the most-crowded field," noted Doug Harmon, co-chairman of capital markets at Cushman & Wakefield. "It seems like a lot of people are shifting into that as a safer quadrant. Lots of people are playing in debt."
The reasons why debt investors may be smiling are not so simply summarized, but a perception of the state of equity and capital markets plays a role. Macroeconomic events, some historically unusual, according to sources, such as the implications of tax reform and the pace of interest rate growth are imprinting upon returns within Manhattan’s commercial real estate market.
"The diminution in value we’ve seen is in no way getting into debt on the capital stack," Knakal added. Rather, it will pull from the equity side.
The tax plan was an unusual event for late-cycle, providing a fiscal stimulus that has increased liquidity, lowered the cost of capital and encouraged capital spending, said Spencer Levy, the head of research for the Americas at CBRE while speaking at the firm's Year Ahead outlook conference.
"The pessimistic view is we are getting closer to the end, but the optimistic view is we have an unusually robust end-cycle economy," said Levy. He does not see the Federal Reserve making a mistake this year regarding decisions on either its bonds-on-balance or its interest-rate increases.
The word 'expensive' has been thrown around. That played into transaction volume last year. Manhattan transaction volume in 2017 totaled $21.6 billion, according to Cushman & Wakefield, or about 45% below the 2016 total of $39.6 billion and 66% below 2015’s high of $63.2 billion.
"Generally speaking, we think core equity is fully priced right now," explained Mike Lavipour, principal at Square Mile Capital. "The 2018 pipeline is shaping up nicely in the credit space so far. The past year was very strong, especially for the credit space in the last quarter."
Lavipour adds that the debt fund segment is growing, as regulatory changes are presenting an opportunity to take from CMBS and banks on transitional and development assets.
Lotus Capital Partners (LCP) founder Faisal Ashraf said, "I think there is a view that everything in New York City is expensive right now," including debt and assets. New debt funds are launching within the Manhattan market to target acquisition and resale of parts of the capital stack.
LCP launched two years ago with the two lines of business: mortgage brokerage and loan sale and distribution advisory. The firm expects to do north of $1.5 billion in total business this year.
"We are contracted by owners of debt to sell off that debt; risk can be a reason but oftentimes we are seeing the need to right-size and/or leverage yield as motivators. We sell off loans and sell of pieces of the capital structure - senior loans, mezzanine loans, etc.," Ashraf says.
"The topic du jour is retail, and we are starting to see more people knocking to get out of their retail commitments," said Tim Taylor, who has been appointed to run LCP’s loan-sale advisory division.
Real estate within New York City and surrounding boroughs has become expensive and investment sales transaction volume has dropped slightly across all sectors, however the middle-market remains a prime area for investment, according to David Schwartz, managing partner of Fort Amsterdam Capital, a division of Sugar Hill Capital Partners.
FAC is a bridge-lending platform focusing on loan origination for multifamily and mixed-use properties and is currently loading capital to developers and operators. Its second fund has raised $50 million in capital.
Commercial-asset owners and investors will always seek to better utilize available capital. In 2017, that adage manifested in a wave of capital-improvements projects. This year, expect to see refinancing as the next-best use, according to experts.
Increased landlord concessions at both high-end and middle-market assets are resulting in rent pressure, Schwartz notes.
"We think this activity has created an influx in loan opportunities, with banks now scaling back, or not being as willing to provide loans. Borrowers have historically made assumptions of net cash flows that are not being realized in the current market. Over the next 12 months, we expect to see an increased volume of loans maturing and borrowers needing to refinance," he says.
"I think we will see a refinance wave in the next 12-18 months but it is not market-driven. It is more a function of what came before. Loans made in 2011 and 2013 are maturing now," McCormick notes, adding that he sees three major buckets of borrowers refinancing: investors who want to refinance now to lock in at a lower rate for the next 7-10 years to extend their debt and sleep better at night; investors who are more reactionary to rates who may be holding and refinancing with short-term or long-term debt; and investors who have improved upon the building and want to take out equity -- "to be able to borrow $10 million at 4% is still a great deal."
It is a matter of perspective, McCormick continues. "Investors doing this for 25 years think 4% is rather low. Someone who has been an investor for only five years, well, they’ve only seen one movie."
In 2018, Knakal said that he sees continued strength in investment activity for New York City commercial real estate. McCormick echoed this, elaborating that he sees 2018 as more productive than the year before.
"There is a better sense of normal. Now we know what the appetite of rate increases is. We know 1031 exchanges are here to stay. There is much more clarity on tax reform. Sellers are becoming more realistic on pricing," he concluded.