New Jersey Capital Markets: What To Expect in 2012

FLORHAM PARK, NJ-2011 was a busy year in the world of real estate capital markets. Despite less than stellar real estate fundamentals, there was and is no shortage of capital for well-conceived investments in the US and specifically New Jersey. New construction, dormant for years, has seen a significant increase across the State with multifamily leading the charge.

This was fueled by extremely low (+/-5%) cap rates, rent growth and a certain exit via Freddie and Fannie. We have seen institutional equity chase these opportunities like no other and construction lenders have competed strongly for the debt. Limited to no recourse is commonplace for the best of class projects. Construction for commercial projects are limited to those with significant pre-leasing much like 800 Scudders Mill Road in Plainsboro, pre-leased to Novo Nordisk for their North American Headquarters. That said, projects like Centra, a 105,000-square-foot spec office building in Metropark and Middlesex Logistics Center, a 570,000-square-foot spec industrial project in Edison, were all done with no pre-leasing. These and other "spec" projects are best of class and lenders are anxious to compete for such projects.

This past year we saw the re-emergence of CMBS, however, it was not without drama. By early summer, European volatility and the US downgrade resulted in AAA rated bond pricing to go from 105 in January to 205 in August. BBB's went from 250 to 800 in the same period. Market experts believed that CMBS would reach $50-60B in 2011 (the high was $230 billion in 2007, 2010 was $12 billion), however, through November they are at about $30 billion.)

Life companies were extremely active and competitive throughout the year as they constantly looked for alternative investments and while treasuries are 2% or less, making real estate investments that earn 3.5% or more is a good business decision. The life company industry invested more money in first mortgages in the thrid quarter of 2011 than any previous quarter since they began tracking this decades ago. Through Q3 2011, life companies had put out $34.7 billion. Prior to 2004, they had not lent that much in a full year. The high water mark was 2006 with $44.1 billion. Given the desire to put the money out, life company lenders have migrated up the risk curve in 2011. This not only includes leverage and pricing but taking lease up risk, going to secondary locations and providing construction/perm loans.

Regionally we have been fortunate to have healthy banks that continue to be active lenders. Now that most have got their hands around their loan portfolios (work-outs, properly reserving against same, marking to market), they are anxiously trying to win more business for their book. In the Q3 2011, banks lowered their net loan to total asset ratio to 51.7%, its lowest since before 1992. Now the window for new business is open. We saw them compete with life companies and the agencies. As mentioned before, they aggressively pursued construction loans with very thin pricing with higher leverage and limited to no recourse. Another active capital source in 2011 was the bridge lending market. These sources provide debt capital to projects in major lease-up or that are part of a DPO (discounted pay off). The cost of such capital has come in tremendously this year. Finally, the agencies. In 2011, Freddie and Fannie continued to be the low cost provider for full leverage multifamily, however, once leverage drops to 65%, life companies stepped in and won most of those transactions.

To summarize 2011, we would suggest that it was a year of great momentum coming out of this last cycle. There is no scarcity of capital and investors are continuing to seek yield which translates to risk. All in all, a good sign for the capital markets.

2012 should be an interesting year from a capital markets perspective. There is an enormous amount of interest from institutional equity and debt investors to fund acquisitions and mortgage loans in the Garden State. Why are we one of the favorite areas in the United States for real estate investment? In spite of the high unemployment rate, corporate downsizing and high personal, corporate and real estate tax rate, New Jersey has one of the most educated, wealthy, and densely populated demographic in the nation. The fact remains that New Jersey offers institutional investors the opportunity to invest is core real estate, which is considered a "safe haven" in these times of volatility in Europe and Asia. Capital flows will continue to look at debt and equity opportunities in New Jersey and 2012 should be as active as 2011 in terms of transaction volume.

Money will be available for mortgage financing from all the local, regional and national money center banks. This money will be available for two to five year loan terms at very competitive interest rates. There will be limited amount of construction debt available and this money will be available to only the "best in class" developers or institutional owners. Ground up construction funding will be available for multifamily projects with above average returns in markets with significant barriers to entry. The life insurance companies will be very active in 2012 for a number of reasons. The pursuit of yields will drive life companies back into the market with large allocations in 2012 and into 2013. With corporate bond spreads tightening, the stock market presenting too much risk, and treasury yields at historic lows, where are fixed income portfolio managers able to get any kind of spread? The answer is back to the traditional whole loans and that is the reason why the large life companies all have billions of dollars to invest in 2012. The challenge will be to find the quality core assets that every life insurance company wants to have as collateral.

What will happen to the CMBS market? The CMBS market should make a strong comeback in 2012 despite the disparity in pricing from the more traditional bank or life company lenders. It will cost borrowers 50-100bps more to fund a CMBS loan versus a more traditional lender but there will be a need for the money for the less "institutional" assets. Spreads will tighten as the year progresses and you will see some of the life insurance companies begin to buy the CMBS paper in an effort to meet their need for fixed rate mortgages. Buying the most senior portion of the debt will help the life companies meet their investment goals and will provide liquidity to the CMBS market, which is what is needed to revitalize the market. The more liquidity in the capital markets the better for it is for all borrowers.

Interest rates should not slow the capital markets down in 2012. The treasury rates for long term paper of seven to ten years will remain in a fairly stable trading range of 2.0 to 3.0%. This will translate to long term mortgage rate pricing in the 4-5% range depending on the asset class and the leverage. 2012 will continue to be "good times" if you are a borrower and less attractive if you are seeking yield.

Institutional equity will flow into two areas in 2012, the highest quality core assets in the strongest demographic markets and into new development in the "gateway cities" along the east and west coasts. The purchase of core assets is strictly for capital preservation and future returns. Investing in new development should produce superior returns once the project is completed and therefore the equity investor is willing to take on the construction risk to secure the higher returns. The demand on these two fronts will drive cap rates lower for existing "class A" properties and will drive development yields lower as investors stretch to get into the game. 2012 investment sales activity should exceed 2011 and the activity will begin early in the year and curtail once the market becomes oversubscribed. When pricing becomes too aggressive, investors sometimes take a pause and this could well happen midway through 2012.

In summary, if you are going to be in the capital markets in 2012 make sure you begin the process early when lenders and investors have a fresh allocation of money and give yourself time to execute the transaction. If the assets are financeable and/or attractive to an institutional buyer you should be very successful in securing favorable debt or securing your price.

Jon Mikula and Tom Didio are senior managing directors at HFF. The views expressed here at the authors' own.