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CRE Finance World, Winter 2014

A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 13 Brian Lancaster: So you’re saying there is a significant cushion between cap and Treasury rates. Some seem to expect the Fed to reduce tapering at the beginning of the New Year or early spring which could steepen the curve and boost long term Treasury rates. So you think there is sufficient cushion for rates to increase without impacting cap rates? How much could rates rise? Ed Glickman: Well, I think the spread between treasury and cap rates is reasonably large at the moment and that could come in a bit before we are going to see cap rates push up. What happens with cap rates in general is it has an immediate effect on valuation, and it’s an effect that’s not homogenous over all classes of real estate. But unlike a decline in interest rates, which can boost everybody’s performance and make all property owners look like geniuses, a rise in interest rates will humble even the best operators. Brian Lancaster: In terms of property valuations, what is driving them? Cheap financing or improving fundamentals or both? Ed Glickman: Fundamentals are getting better because there has been a decline in construction in the post-crisis period, and there’s been some absorption. But over the long run it appears that there are fundamental societal changes going on that are diminishing the per-capita demand for real estate. That serves as a counter-point to the recovery. Things like people ordering goods and services online and other trends in office utilization, which even though we are increasing the number of office workers as part of the recovery, the space per office worker will go down. Brian Lancaster: What are your views on the property markets and your outlook in 2014? Ed Glickman: Yes, my view for 2014 is that we will have relative stability in the property market, because I don’t see interest rates rising rapidly, and certainly not rising to the extent that they are going to significantly impact cap rates. I believe it’s still a good opportunity for purchasing properties in 2014 because the financing rates are reasonably low, you can lock in a long term spread. When interest rates rise, economic growth is going to bring them some rent increases, and for owners who have a locked in spread, that that is going to improve their cash flow. The folks that are going to be hurt by the rising rates are those who have financing that comes due in 2014 and 2015, where they haven’t yet seen the benefit of improvements in rents and yet are faced with higher mortgage rates. Brian Lancaster: Which sectors do you think should do better? You mentioned office and the ongoing shrinkage in space demand. Of the major food groups, office, hotel, retail, multifamily, industrial, are there any specific property types or regions you like more than others in 2014? Ed Glickman: I think that what we are going to see, rather than a shift between property sectors, is a shift out of the core markets to the secondary markets. We will see cap rate compression down the quality scale. So, in the markets that haven’t benefited from liquidity, and they haven’t really benefited from the flow of capital, as investors who are still going to be seeking yield look further than the core markets, they are going to start to buy properties in the secondary cities, and we are going to see some cap rate compression there. In terms of the individual sectors, my favorite sector in the real estate market for the next year or two is the housing sector. I think single family housing is prime for some significant growth. I think multifamily housing may be a little overpriced at the moment. There has been some significant building as it was everybody’s favorite sector for the last few years, and we’ve seen some growth in supply, so I think that is may be overheated at the moment. But I would say for the single family housing industry, the typical demand for housing is about 1.4 million units a year. We are still at less than about 1 million units so we are still eating into inventory. Inventory at this point is down by half from the post-crisis peak to about five months, which is a very low level historically. So, I’m bullish about the housing market. Brian Lancaster: Richard, you mentioned to me how you are moving more into secondary property markets. Could you expand on this? Why and are others doing it as well. Richard Walsh: Sure. We are finding that from an acquisition point of view, the major property types in the primary markets are pretty much overbought. So capital is pushing into other markets in search of higher returns, and I think the timing is probably correct. The recovery that first took hold in the tech and energy related markets is starting to expand into some of the stronger secondary markets — markets where not only are we lending, but where we are also trying to acquire assets. You can look at Atlanta, where the vacancy in the office market has dropped from about 20% to the low to mid-teens. You can say the same thing in Miami. Although these markets have taken longer to recover, there has been relatively consistent improvement for several years now. Brian Lancaster: You mentioned Atlanta, Denver, and Miami as attractive or improving what other cities and property types do you like in 2014. Richard Walsh: We’ve seen loan demand in Minneapolis, and I’ve mentioned Atlanta and Miami. We’ve also had increased interest in Ft. Lauderdale and West Palm. 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CRE Finance World, Winter 2014
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