Peter Keepper
Principal, Essex Financial Group LLC, Denver
Interest rates are currently at record lows and acquisition transaction activity appears to be picking up pace due to a combination of factors. The Brexit disruption in the capital markets recently resulted in record-low Treasury and swap rates as global investors sought a flight to safety. However, spreads haven’t widened out by the same margin.
The 10-year Treasury reached a low point of 1.37 percent one week after the Brexit vote but climbed back to 1.5 percent the following week. The last time the 10-year Treasury was less than 1.5 percent was in in July 2012, but spreads were wider and fixed rates were higher. Spreads have widened as usual during a flight to safety, but demand for alternative investments such as high-yield corporate debt has increased, resulting in spreads widening by approximately 10 basis points as the 10-year Treasury fell by 40 basis points during the first week of July. The majority of general account lenders have established rate floors since the Brexit vote thinking the record-low Treasury rates that hovered around 1.4 percent were an anomaly the following week. Low-leverage loans for 10-year terms can be obtained in the low 3 percent range and rates for full leverage loans of 65 percent on commercial property are in the mid-3 percent range, which are 40 to 50 basis points lower than a year ago.
Many sellers planning to list their properties for sale at the beginning of this year based on pricing expectations established in 2015 have been disappointed with reduced demand as investors appeared to be contemplating if the current cycle reached its peak. The increased risks with a substantial slowdown in China, major disruption with the oil and gas markets and the looming potential for Brexit all seemed to combine to result in some pause in the first half of the year.
What has changed is mainly an improved outlook for the U.S. economy combined with a lower cost of capital for commercial real estate investment. A week after the Brexit vote, the Labor Department reported 257,000 jobs were created in June, compared to only 11,000 in May. The Dow shed 900 points prior to Brexit and has now recovered to new highs, trading at an average price-earnings ratio of 17. Interesting how sentiment can change, but it’s likely more due to the United States being the best international economy for investment considering U.S. corporations pay out one out of every three dollars in global dividends and the U.S. economy is near full employment. Demand for U.S. Treasury appears to be at a high point as international investors are simply more confident in the U.S. economy vs. the rest of the world. Although the U.S. national deficit is at an all-time high, America is still the cleanest and largest dirty shirt in the pile that is paying out positive rates.
Fixed interest rates with securitized lenders are now in the low 4 percent range – down around 90 basis points from their high point of mid-5 percent near the end of the first quarter. The spike in commercial mortgage backed-securities interest rates in the first quarter caused acquisition demand to fall further. Life insurance and general account lenders benefited significantly in the first half as CMBS originators couldn’t compete on rate or certainty of closing. Many have originated over 75 percent of their mortgage allocation goals for the year.
This window of record-low rates may be an opportunity for some investors to buy properties at cap rates that are 50 to 100 basis points above where similar properties were trading 12 to 18 months ago with a lower cost of capital. It’s a great time to be a borrower at this point of the year. Although refinance activity has been very strong in the first half of the year, acquisition financing should pick up pace in the second half if national investor confidence continues to increase along with demand from foreign capital.
