Can We Avoid Another Bubble in CRE?

DALLAS-With interest rates for commercial real estate debt at historic lows, investors are scrambling to get their piece of the pie before rates creep back up as the Federal Reserve begins tapering its stimulus. In my last GlobeSt.com column, I wrote about the new generation of commercial mortgage-backed securities and whether lessons learned from the crash of 2008 would inform future decisions. Evidence from the past several months may indicate that we are “playing with fire” and walking a fine line given the reintroduction of “interest only terms” and a continued emergence of increasingly aggressive underwriting terms.

During my recent panel at the Crittenden Real Estate Finance Conference in Miami, the hot topic was the Fed and Bernanke's involvement in generating stimulus for the economy, a subject that has a big impact on commercial real estate. The market's wild movement and the interest rate spike after the Fed announced it would reduce its stimulus is a sure sign that we are still facing uncertain times.

Of course, this is not the tune that CRE professionals want to hear.  Many are still singing “Happy Days Are Here Again,” but there may be a rude awakening around the corner if investors do not adopt a cautiously optimistic attitude.  I'm not saying the sky is falling but I don't believe we are out of the woods yet either.

Continued government stimulus will only serve to distort markets and statistics, invite inflation and foster environments where bubbles emerge.  Look at the stock market.  Today's market is growing daily as additional players enter the market, moving some lenders and borrowers alike to sacrifice quality of underwriting for winning the deal. Interest rates and cap rates continue to present the greatest risks, and rewards, for investors.

Here are my tips for getting the best value out of your commercial real estate investments now:

If you're close to meeting your investment targets, test the market for selling now. Your return is likely to be higher today than it will be in three-to-five years.

Interest rate risks will only increase from here. Current interest rates for CRE debt remain low, but they are beginning to creep back up. Commentary from key originators like Freddie Mac, indicate they are modeling rates to rise 100 base points year-over-year through 2016.  Near-term stable or lower interest rates are unlikely, and higher rates in the future will require stronger performance from assets than may be possible.  If you are thinking about buying, stress the investment for an uptick in rates.

The market has not cleared all of the distressed real estate investments. 

While market movement is a daily occurrence, today Special Servicers are still working through approximately $45 billion in CMBS delinquencies, with another $1.5 billion transferring with the September remittance. While resolutions are up as well, Morningstar reports approximately $52 billion will mature annually through 2017. Not all these deals will size to current underwriting standards, suggesting there are still three-to-four years of inventory left to resize and refinance.  This will continue to impact an otherwise improving economy.

While the risk appetite is different for all investors, you will be a winner if the bubble bursts if you  strategically evaluate individual investments and portfolios on a regular basis, starting now.   

Tanya Little is founder and CEO of Hart Advisors Group in Dallas. The views expressed in this column are the author's own.