Everyone is obviously happy that rates remain historically lowand are likely to stay there for quite awhile. It allows betterpricing for debt than we all would have anticipated. Banks are ableto compete heavily for major property loans on the best assets withthe best borrowers at rates that few of us would have expected afew months ago. So long as bank lending in general is at low levelsand banks can take deposits and borrow at record low levels, theywill continue to pose a competitive challenge to CMBS lenders forthe better quality deals. They also offer borrowers betterflexibility and servicing.

What seems to be happening is many people are not sufficientlyconsidering that rates will be rising during the hold period formost assets. At some point the Fed will end its bond buyingprogram, and will start to need to sop up the excess liquidity inorder to prevent another bubble. The economy will recover and thecombination of Fed tightening and reductions in money supply, willjoin with rising rates to present a possibly different borrowingmarket. In three or four years, when investors might beconsidering selling or refinancing, the debt market could look verydifferent. Underwriting is likely to continue to be conservative,and LTV is likely to remain in the 65%-75% range and be basedmainly on cash flow. If rates have moved up by say 250-300 basispoints on the 10 year, then proceeds to a new buyer at that timewill probably constrain what price he can justify. Rents will havestabilized and hopefully be rising again, but new long term leasesfor office and retail will have been signed in the interim attoday’s lower rates. In short, it is hard to properly project whatdebt will be for a buyer in three to four years, and whereinflation will be, so it is very hard to accurately figure outterminal values at that time in any model done today. It is likelybest to use a range of values and determine if being in that rangestill provides a justifiable return. Making an assumption thatthere will be large value increases and plenty of cheap capital isnot likely to provide an accurate estimation of the validity of theinvestment under consideration.

Core returns seem to be settling in around 7.5%-8.5%. Returns onother assets are sloping upward from there. Most serious investorsare taking the approach that there are so many unknowns right now,that it is not a time to be going way out on the risk curve. Whatwill happen in the next Congress, will Greece default again(likely), what will Dodd Frank and Elizabeth Warren do to bankearnings and ability to make loans, will there be another terrorincident, will the Fed overdo bond buying, what effect will therestructuring of the rating agencies have on CMBS issuance, willIsrael attack Iran, will the decline of the dollar cause majorinflows of foreign capital, will inflation spike in three years,will Obamacare be revised or declared unconstitutional, what willhappen to the refi of the $1.5 trillion of CRE loans maturing inthe next few years, how long before the residential mortgage messif clarified. Clearly there are many black swans circling and anyof them could cause major disruption. As a result, the smartinvestors are seeking solid buys even if they are buying distressedpaper. They are shooting for a 15% all in return and no longer arelooking at trying to achieve 20%+. They are keeping leverage atmanageable levels and not betting on big jumps in projected cashflows to make the loans work.