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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   January 2018

Viewpoint: Commercial Real Estate Remains on Solid Footing

Its future, however, is being shaped by dynamic market and policy forces

The commercial real estate market has experienced substantial growth and evolution, and continues to be a vital sector of the U.S. economy. As evidence of that fact, according to research by the Mortgage Bankers Association (MBA), total commercial and multifamily debt stands at some $3 trillion, delinquency rates for commercial and multifamily mortgages are at or near record lows for most capital sources, and growth in property incomes and property values — coupled with relatively low interest rates — have facilitated financing activity.

The rapid increases in property values, transaction volumes and other fundamentals that characterized the post-recession period for the commercial real estate sector have recently given way to more typical economic changes, however. Commercial and multifamily market activity has clearly downshifted since the start of 2017, but the fundamentals of the market remain sound.

Market dynamics

During second-quarter 2017, the already tight apartment market saw vacancy rates tick up to 4.4 percent, with rents rising 3.6 percent on a year-over-year basis. The office-vacancy rate declined 10 basis points from a year earlier, with average rents up 1.6 percent year over year. Retail vacancy rates grew 20 basis points from a year earlier, to 10 percent, while average rents rose 1.7 percent.

Commercial and multifamily property-sales activity started 2017 slowly, with the pace of property sales 7 percent slower during the first half of 2017 than during the same period in 2016. It is not surprising that multifamily led the declines in 2017 because of the heat of that part of the market over the past few years, with sales transactions 16 percent lower than what was seen a year earlier.

Office-property sales were down 1 percent and retail sales were down 12 percent over the same period. Sales of industrial properties, referred to by some as “the new multifamily” because of the high interest in the sector, were up 12 percent. Commercial real estate borrowing and lending started 2017 on much the same footing it ended 2016. As 2017 came to a close, multifamily remained hot and industrial was heating up, while there was a widespread perception that retail was cooling.

Multifamily properties remain the key force behind overall origination trends, and the government-sponsored enterprises (GSEs) continue to drive multifamily originations. Matching broader investment themes, financing backed by industrial properties also picked up in 2017, while retail declined. Investor and lender appetite for property types can be driven by perception, in addition to fundamentals.

Regulatory environment

The laws of supply and demand are not the only forces that govern the commercial real estate market. The policy environment presents challenges and opportunities to commercial real estate finance and the overall market. Mortgage bankers, brokers, capital providers and other industry participants should be aware of these issues that can significantly impact credit flow to the industry.

Commercial and multifamily market activity has clearly downshifted since the start of 2017.

One critical issue facing banks involved in commercial real estate finance is the Basel III HVCRE (High Volatility Commercial Real Estate) capital requirements and their impact on bank acquisition, development and construction lending. As drafted, the rule hinders the ability of banks to provide this financing.

Banking regulators have released a notice of proposed rulemaking that offer significant reforms of the HVCRE rule, clarifying some questions but also raising important new ones. Bipartisan legislation (H.R. 2148) that would address several limitations in the federal banking agencies’ regulations governing the definition an HVCRE loan was introduced this past April by U.S. Reps. Robert Pittenger, R-N.C., and David Scott, D-Ga. The bill was passed by voice vote in the House and referred to the U.S. Senate Committee on Banking, Housing and Urban Affairs, where it was still pending as of this past November.

Another key policy matter, tax-reform legislation, which was still being debated in Congress as of this writing, is also expected to lead to profound changes to the commercial real estate landscape. Issues such as business-interest deductibility, 1031 like-kind property exchanges and the low-income housing tax credit are critically important to the industry. The MBA has formed a board-level task force to remain closely engaged on the path to tax reform, advocacy on industry priorities and impacts on the real estate markets.

One of the other challenges facing the industry, and particularly important to the multifamily sector, is the need to reform the GSEs — Fannie Mae and Freddie Mac. The GSEs play a significant role in the market: Almost two-thirds of the first-quarter 2017 growth in outstanding mortgage debt came from multifamily, and 80 percent of that growth came from portfolios and mortgage-backed securities held or guaranteed by federal-government agencies and the GSEs. Whether a lender works with or competes against the GSEs, comprehensive reform is vital for the future of the mortgage markets. 

A number of proposals have been advanced for dealing with this critical issue of GSE reform, which the Trump administration has promised to tackle. The MBA’s reform proposal, for example, seeks to preserve what works in the current system and enhance the stability of the market, while protecting taxpayers and consumers. MBA’s plan addresses both multifamily and single-family markets, affordable-housing requirements and offers a transition framework for how to get the system from its current state of conservatorship to a new end state.

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Fundamentally, the commercial real estate finance industry provides American neighborhoods, cities and towns a sense of place. Office, retail, multifamily, industrial and hospitality properties are indispensable components of our communities. Our industry, markets and public policies must work in tandem to sustain this vital ecosystem that serves as a key support for our economy.


 


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