Real Insight. Real Estate.

Posts Tagged ‘yields’

As we round out 2009, one of the most interesting top 10 lists we could conjure deals with all of the various changes in the capital markets as it pertains to the commercial real estate sector.  The availability of capital has diminished significantly, and for capital that remains available, return requirements, interest rates and loan terms have all changed substantially.  Let’s take a look at the top 10 changes:

10. Shorter amortization periods for fixed rate loans by 5-10 years - Many banks have cut back the amortization schedules on loans from 30 years to 25 years, and from 25 years to 20, or even 15 years in some asset classes. Shorter amortization periods means more expensive annual debt service payments.  This of course has a subsequent effect on cash flows as well as tradition debt service coverage ratios.

9. More equity deals being structured with debt-like components - Equity partners have shifted much of the weight of their return to their preferred position.  This, of course, means that they face losing significant upside on strong deals.  However, they seem to be happy to trade that upside return potential for greater security of their minimal required return.

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Bloomberg published an informative article yesterday highlighting the reasons why debt financing is so much more expensive for governments than private companies.  You would think that governments that NEVER default on debt issuances and have unlimited tax revenue could issue debt at a cheaper cost than private companies.  Municipal bonds, however, are often issued at rates anywhere from 100 to 150 bps higher than private companies.  What’s the reason for this?  Moreover, what lessons can an owner/investor of commercial real estate learn about debt financing from the municipal bond market?

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Real Questions…

…. and Unintended Consequences

Question 1:

If you are a buyer of real estate (and actually have capital), what sort of IRR are you looking for? 20%? 30%?

Question 2:

If you are an owner of real estate, why on earth would you sell into this market unless you absolutely had to?

These questions succinctly sum up the entire commercial real estate market. Other statements examine facets of the problem, but they all revolve around this problem we’ll call, “The Bid/Offer Spread”.

Every day, the fund managers who still have jobs wake up, read the Wall Street Journal and say to themselves, “If I’m going to buy a property, I deserve a discount.” Any possible ‘green shoots’ notwithstanding, unemployment is high, the economy is in recession, global icons are getting destroyed (or taken over by the government), and the banking system as a whole is only viable because the Feds have stepped in with HUGE assistance programs. You can also throw in the fact that recent liquid market action (rally in gold, commodities and TIPS while the 10yr notes sells off ) is telling us we might even have an inflation problem in the not-so-distant future. Read the rest of this entry »

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