Like the poor dog in that Traveler’s Insurance commercial who wonders where to hide his bones while Ray LaMontagne’s “Trouble” plays in the background, few investors can find a safe place to stash their money. Even with rampant inflation, it may seem better to bury money in the yard than invest in stock or bond markets given recent performance.
But where does the uncertainty leave commercial real estate investors? With the 10-year Treasury yield in the mid-3% range, which is higher than it has been since the early months of 2011, borrowers are choking on commercial mortgage rates.
According to the John B. Levy Commercial Mortgage Survey, 5- and 10-year mortgage rates are now between 4.80% and 5.25%. Floating rate loans are priced relative to SOFR and are still quite low, but floating rates are now expected to match or exceed these fixed rates by the end of July.
The best prices come from lenders who do not depend on the capital markets, ie pension funds, insurance companies and banks. The worst pricing comes from conduits, whose pricing is entirely tied to how they can sell their underlying bonds (commercial mortgage-backed securities, or CMBS). Since these bonds are extremely volatile right now, prices are wide and will likely remain so for some time.
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Due to dislocation in capital markets, loan volume for bridge lenders is down about 26% year-to-date compared to a year ago, according to Commercial Mortgage Alert, an industry publication. .
Generally high rates and volatility in capital markets make new investments more difficult, but for owners of hotels, industrial properties and apartment buildings who are locked into long-term rates, these inflationary times are quite acceptable. Indeed, apartment and industrial property rents and hotel room rates are rising rapidly.
Unsurprisingly, house prices continued to rise along with rents. Although the expected slowdown in interest rate rises is not reflected in the latest data, according to an MSCI index, which tracks commercial property prices across the country, prices rose 17.9% in April. (year over year) for all property types. Industrial real estate prices rose the fastest at a rate of 26%, and apartments were not far behind with prices rising 23%. Commercial real estate prices are also on the rise and rose 18.4%, according to the index.
Meanwhile, anyone who has stayed in a hotel recently realizes that room rates have risen faster than inflation. A recent interview with the CEO of Marriott revealed that the hotel operator found that the RevPar (revenue per available room) of Memorial Day weekend in 2022 exceeded the same long weekend in 2019 by 25% for all Marriott brands.
Apartment List recently reported that apartment rents across the country rose 15.3% year-over-year in May, not as fast as the 17.5% growth reported in 2021, but still at a crazy inflationary rate. Rents in Richmond’s MSA rose more modestly at 12.9%, year-over-year, but May’s rent growth ranks the city as the 18th-fastest-growing rental market in the nation.
Although real estate is generally considered a decent hedge against inflation, there are many factors to consider. For now, most investors are still banking on rental growth continuing to outpace inflation.
John B. Levy & Co. partner and investment banker Andrew Little can be reached at [email protected]