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CREFW-Fall2014 10.15.14

Are Capital Market Cycles Shortening — And So What If They Are? ike every part of the economy, real estate finance moves in cycles, from boom to bust and back again. Some evidence suggests that these cycles are moving faster than they used to, picking up speed and compressing what used to be decades-long trends into just a few years. This shortening is creating both opportunity and risk for investors. Are Cycles Shortening? Historically, real estate finance cycles have been measured in years and decades, following a well-documented sequence of boom, slump and recovery. The real estate boom of the early and mid-1980s was followed by the tax law change of 1986 and the slump in the early 1990s. What followed for the next five years was a lack of capital in the real estate sector, the S&L crisis and the RTC. In 1994 and 1995 capital began to flow, in part due to the start of CMBS, and the real estate markets pulled out of the slump. For the next 12 years we saw a strong real estate market punctuated only by the short lived Russian Rubble crisis of 1998 and the Dotcom bubble which burst in ’99 and 2000. We saw strong and steady growth from ’95 to ’07 in nearly all areas of real estate — both commercial and residential. The most recent cycle points to a different pattern: a severe contraction, followed by a quicker-than-expected recovery. The slump that began in ’07 and picked up steam in early ‘08 was the most severe since the Great Depression, and real estate finance contracted suddenly and drastically. The realization that real estate values, especially residential, can go down slapped the real estate market into reality. The recovery was expected to be long and difficult. However, the worries about the mass refinancing of 10-year commercial loans dating from the mid-2000s turned out to be somewhat overblown. Those who thought that the take backs, workouts and opportunistic buying opportunities would drag on have been disappointed. Unlike the more sluggish recovery of the broader economy, commercial real estate lending bounced back more rapidly than anticipated. While we continue to see maturing CMBS loans going to special servicing, we also see an abundance of capital available for refinancing commercial real estate as well as a significant amount of new construction money. The Mortgage Bankers Association (MBA) reports that total outstanding commercial and multifamily mortgage debt rose rapidly in the mid-2000s to reach a high of about $2.5 trillion just as the slump began in early 2008. Total debt dropped for a few years, but by 2013 origination volumes had rebounded. The fact that a steeper slump had a recovery about as long as a moderate recession CRE Finance World Autumn 2014 6 argues that cycles are different than they once were, since deep declines have historically been followed by long recoveries. This recovery, however, has quickly become a strong market. While CMBS volume has not returned to the ’06 and ’07 levels, the ’13 volume and projected numbers for ’14 are a very healthy $80 to $100 billion. No one can argue that we have a shortage of capital for real estate finance – in fact it could be argued that we are well on our way to creating another bubble. We saw the downturn of the late ‘80s take five years for recovery followed by 10 years of largely steady growth and a couple of years (’06 and ’07) of full out “irrational exuberance.” In contrast, the downturn that started in late ’07 for real estate only lasted for three or four years with opportunistic buying beginning to play out by the end of 2010. Figure 1 Year-over-Year Percent Change in Commercial and Multifamily Mortgage Debt Outstanding Source: Federal Reserve Board, Flow of Funds Account of the United States Why Would Cycles Shorten? It is not entirely clear, but there seem to be temporary as well as more structural reasons. Lenders might have been burned by the late 2000s contraction in the economy and real estate, but are now living in a low-interest rate environment and a need to generate return on their capital. Whatever risk aversion lenders felt a few years ago, they need returns now, and commercial real estate loans offer much-needed yield. Are the low interest rates contributing to the rapid return to aggressive lending or simply an irrelevant factor brought on by quantitative easing? L Clay M. Sublett Senior Vice President – Southwest Regional Executive KeyBank Real Estate Capital®


CREFW-Fall2014 10.15.14
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