Transaction volume has been growing rapidly since things began turning around in 2009. When transaction volume rose over 25 percent year over year at the end of 2015, it almost reached levels seen in 2007 and had everyone holding their breathe as to the sustainability of the market. Fortunately, this go around, the market conditions were different than last time in that lenders and the capital markets as a whole saw the benefits of remaining conservative and disciplined. This has kept money from pouring out into the market for the sake of pouring money out there, which has kept both buyers and sellers on their toes to make sure the numbers still work for the deals they are engaged in.
With that being said, there is still a ton of transactional velocity out there and deals are still getting done. Even though the availability of capital in 2017 has been pulled back a bit from 2016, there is still a ton of capital out there for real estate investments. The slight cooling off has even been perceived as a good thing to help keep the market at a steady hum opposed to the drastic spikes of an unsustainable rise leading to another dark dip. The conservatism in lending has led to an interesting shift in the availability of capital, however. From the data on the chart on the right, you will notice that commercial banks ranked last in availability of capital for real estate as compared to other lending sources in 2017. We have seen it from our end too; lenders that were bullish on lending for commercial deals have put a hold entirely on funding any new projects while they let the current dust settle. In addition, banks have a hard time exploring outside of the strict parameters that could attract more regulatory attention. That has opened up opportunity for other lending sources to lead the pack.
Commercial banks, over time, are expected to remain major players in the capital lending realm for real estate, it is just unclear as to how these shifts will change the dynamic for their deployment of capital. Commercial banks still house a huge inventory of real estate assets on the books. Although lending may be slower for commercial banks overall, the strength and stability of those lenders remains intact. To pair with that, we are also still seeing a number of lenders with a strong appetite for commercial lending and deals are getting done.
The availability of capital for development can still be a tricky path to navigate. The chart on the left shows that debt capital for development/redevelopment in 2017 was largely undersupplied versus 2016. Aside from that fact, however, most of the real estate capital market metrics have remained in balance. The influx of cash into the market from the increase in transactional velocity has compressed cap rates to levels much lower than we saw during the last cycle, however, with interest rates still historically low, buyers are still making money. Lenders have been forced to get competitive, which has narrowed spreads along with a few slight adjustments from the FED, but spreads are still hovering at healthy levels; gross spreads are still around 200 basis points, compared to a 100-130 basis point spread back in 2005-2007. Inflation is expected to remain fairly stable and at current levels over the next five years, but interest rates will undoubtedly creep up at a moderate pace within the same time frame. Both debt and equity underwriting standards are forecasted to become more rigorous as we continue to push forward in this market. As a result, it is likely that values and cap rates will shift in conjunction to maintain a healthy spread and return for investors. As long as the process is fairly gradual, it should provide more opportunity for buyers as debt on commercial assets comes due, while also providing a healthy post peak sales environment for owners to consider accessing their equity at a higher level than they entered into the investment and moving that equity into other commercial investments with continued upside in the future.
CMBS debt may have been one of the biggest question marks as the market has shifted over the past few years, but it appears that debt has matured at a healthy pace with the market and CMBS should have enough capital available to be a strong contributor to deal flow over the next number of years. Although we have seen a bit of a pullback, the consensus in the market is that the pullback is a healthy one for the market. Outside of any major economic shift, the real estate market is anticipated to continue moderate growth over the next couple of years due in large part to the health of the capital markets. The increase in construction costs and continued challenge of finding funding may slow down development to an extent and it may vary across different commercial sectors, but that could simply lead to rent growth and appreciation over the short term. Values for real estate in this market may have plateaued, but are still above and beyond any values that were attained during the last peak. The difference is that this peak appears to be more stable and supported than some of the smoke and mirrors experienced last go around.
If you are an owner or investor considering your options in the market, please feel free to reach out to us directly. We welcome the opportunity to learn more about your specific situation and help you understand your options for accessing your equity through a sale or refinance, as well as your option of holding the property strategically to add value over time. There is a lot of work we can do together outside of a transaction to help ensure you maximize the value of your real estate investments. You can reach James Garner or Jim Shiebler with any specific questions around the market, your existing investments, or what available investment inventory might be a good fit for you.
For more information on what happened in the market this year, contact us directly about our Annual Restaurant Report.