What next? At least that’s where my head has been recently, and I am certain that I am not alone. Last month, it was a client telling me that “65% is the new 75%” regarding construction financing leverage based on HIS expectations of what the market would bear, then it was the shocking election result and the immediate 60+ basis point increase in the ten-year treasury that followed (still rising by the way). Bear in mind this increase involved no action from the Fed (expect their relatively meaningless announcement of an increase to come at the next meeting Dec 14th), and now we head into the new year on the eve of yet another layer of bank regulation taking effect (I am sure you have read about risk retention at this point), while at this very moment there is an administration being formed that is working on repealing major parts of the Dodd-Frank Act if not the entire bill. Either way, the added regulation is not going to increase the availability of capital in the short term.
So, one could look at the above data points and say that there are a lot of signs that there are is going to be a meaningful tightening of capital availability coming in 2017. And that’s probably true, along with a decreased volume of investment sales transactions due to higher rates equaling pricing pressure. But on the other hand, and where I myself fall, there is a belief that we are slowly returning to some type of “normal.” Recently I attended the Urban Land Institute’s Philadelphia 2017 forecast, which was presented by Mitch Roschelle, of Pricewaterhouse-Coopers. As an aside, if you have never had the opportunity to hear Mitch in person I would recommend it, he is both entertaining and insightful.
Among the varying themes that Mitch brought up was the idea of the real estate market “auto-correcting,” which is a concept that I found to be particularly interesting. While I don’t think that society has evolved quite to that point, and I am certain that most of the same mistakes that resulted in the financial crisis are destined to be repeated, I do find an element of truth in the concept. Clearly banks have tightened their purse strings on development lending, and while it would be too easy to say that it is all a product of the new regulatory environment, there seems to be an element of human common sense involved in this turning of the tide. In other words, perhaps lenders notice when they are on their way to the office that there sure are a lot of cranes in the sky of every downtown in the Northeast, even though when they get to their desks there is a handy stack of market reports to tell them that there is tremendous underserved capacity for urban housing.
So, a modest rate increase and a little bit of decreased supply of the availability of construction financing is, in the author’s opinion, not only not a cause for concern, but a reason to feel confident about the commercial real estate market. A modest cooling has the potential to increase the life of the current cycle that we have all been enjoying for the last several years (that may be my toast for 2017).
R. Brenner Green is a 19-year veteran in commercial real estate finance and President of Real Property Capital, Inc., a full service commercial mortgage banking firm based in the Philadelphia suburbs.