LOS ANGELES—It has been an interesting year to say the least for the debt and equity markets. Although the markets have recovered somewhat since then, we are in a much more challenging market today than last year, according to Jay Maddox, a principal at Avison Young. With a quarter left in the year, we sat down with Maddox for an exclusive interview to take a look inside the debt and equity markets, see how things have changed and where they are heading—and we ask the question that has the most well-informed experts debating: are we in for another recession? Here, Maddox answers all of our questions.

GlobeSt.com: Compared to six to 12 months ago, are there more challenges for investors and developers to secure debt today?

Jay Maddox: We are clearly in a much more challenging market than a year ago. Banks are being more selective and pricing has increased. In particular, this has affected the construction lending market with financing standards that have definitely tightened due in large part to new capital adequacy regulations under Basel III. Yesterday's 65% loan is now 55%, and pricing is higher. There is also concern about continuing to lend on development at this point in the cycle, and some lenders are keeping their powder dry for existing relationships only. This retrenchment has opened the door for debt funds and private equity lenders who can be more flexible, but they are more expensive. We're also seeing increased availability of mezzanine and preferred equity financing that is providing additional leverage on larger, better quality opportunities. So, the money is still there for good projects and strong sponsors, but it's definitely tougher. Private equity investors are also “tapping the brakes” citing concerns that the cycle may have peaked and today's high rent growth may not be sustainable.

GlobeSt.com: Can you provide your thoughts on the state of the CMBS sector this year?

Maddox: The CMBS sector has had a few speed bumps this year – consequently, overall issuance is below levels that were projected at the beginning of the year. The market was hit hard by the unexpected BREXIT vote in the first quarter, which triggered significant fallout, and a number of CMBS issuers closed up shop in the spring. CMBS issuance activity recovered somewhat during the second quarter, then the market corrected again in the third quarter as Treasury rates increased some 40 basis points from July lows. At the same time, CMBS spreads widened due primarily to increased market volatility and also to the new risk retention requirements for CMBS issuers under Dodd Frank phasing-in during January 2017. CMBS issuance is now fairly steady, with new issues including risk retention tranches. However, overall volume is still far below pre-recession levels. Fortunately, commercial banks, life companies, debt funds and the GSAs have stepped in to fill the void, so financing availability remains good.

GlobeSt.com: What about the so-called “Wall” of looming CMBS loan maturities?

Maddox: As has been widely publicized, many of the CMBS loans coming due this year and next are 2006 and 2007 vintage 10-year loans that were aggressively underwritten during the “Bubble.” While CMBS delinquencies remain very low, there have been some recent increases. Many of these loans are now underwater or cannot be refinanced without new equity. Loans that were previously extended are also part of this population. The most challenging sectors will be retail and office, both of which have faced significant pressures due to technological disruption. Retail malls, especially older projects in secondary and tertiary markets, have faced tremendous pressure from e-commerce as major box stores such as Macy's and Sports Authority have retrenched or gone under. Office properties have come under increasing pressure as well. While other sectors such as multifamily have recovered, office vacancies have not improved as much. The average square footage per employee has plummeted as competing demand for creative office product has expanded, crowding out the demand for traditional space, and cloud file storage has replaced physical. Therefore, we expect some increase in delinquencies and foreclosures if these properties can't be sold or refinanced by the maturity dates.

GlobeSt.com: Do you feel we will see a downturn in the coming months?

Maddox: A lot of people are concerned about the prospect of another downturn and potential increases in non-performing loans. In fact, a recent Bloomberg survey of 31 leading economists predicts a recession in the U.S. economy in 2018. There are a number of signs that a slowdown is occurring in CRE valuations, but in my opinion, a wholesale collapse similar to 2008 and 2009 is very unlikely because the run-up in valuations has been fueled by global liquidity and good underlying fundamentals, as opposed to excessive leverage and speculation that occurred before the Great Recession. The biggest risk factor is rising interest rates; if this continues it could definitely put a damper on CRE valuations.

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We Are in a Much More Challenging Market Today

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