Commercial real estate continues a strong performance. The Mortgage Bankers Association just released the Commercial/Multifamily DataBook for the second quarter of 2015, summarizing its latest research into trends and conditions in the commercial mortgage industry.
As expected, the publication reveals the industry enjoyed continued economic growth throughout the second quarter of the year. The seasonally adjusted annual growth rate for the US economy overall was marked at 3.9 percent, with job growth also strong at a seasonally adjusted 230,000 jobs per month. Specifically, MBA reported that mortgage originations increased by 113% in the government-sponsored (Freddie Mac/Fannie Mae) sector while CMBS loan originations increased by 64%. The second quarter of 2015 also marked the first time multifamily mortgage debt has surpassed $1trillion, growing at almost 10% a year. According to the Federal Reserve Board, Credit quality was unchanged or improved in key districts, and delinquencies remain. Though low interest rates and generous terms for commercial real estate mortgages and construction loans were reported in Boston, credit standards were largely unchanged in other Districts.
Good times are expected to continue according to the consensus forecast recently published by the Urban Land Institute (ULI). Though the survey of economists and analysts from 36 leading real estate investment, advisory and research firms yielded slightly less bullish results than the previous consensus, responses suggest continued economic expansion over the next three years, with improved CRE transaction volume, price appreciation and rental rates. Issuance of commercial mortgage-backed securities (CMBS) are forecast to continue to grow steadily throughout the next 3 years, from $110 billion in 2015 to $130 billion in 2016 and to $140 billion in 2017. The consensus is supported by other sources. Jones Lang LaSalle, for example, reports that office and industrial real estate are improving in most districts, though peaks may be approaching in office markets in San Francisco, Silicon Valley, Dallas, and a few others, and retail continues to lag general market. Likewise, more recent reports by the Federal Reserve indicate strong real estate markets throughout the country. Construction lending, in particular, continues to increase, though a lack of skilled labor continues to influence upward movement of construction costs in many districts. Lead times for construction materials are also affecting market conditions. Turner Construction’s Quarterly Building Cost Index reports an average construction cost annual increase of 4.52%, with the impact of labor and material cost increases partially offset by lower energy costs.
With the last recession still fresh in mind, the surge in commercial real estate has led to concerns about a new bubble. The surging market and growth of real estate prices year after year makes it easy to believe that real estate investment is a no-brainer, but the cyclical nature of commercial real estate means that periodic correction is part of the normal state of affairs, and predicting the next bubble can be problematic. Post-recession studies conducted by the Office of the Inspector General showed that failed banks had tended to be overly optimistic during the preceding bubble, frequently significantly increasing their commitment to commercial real estate without adequate controls in place. The result was catastrophic for many, while more rigorous lenders fared better during the downturn. Like lenders, investors profit from taking risks; but gambling on unknowns can lead to disaster. Investors can protect themselves from downside risks, but relying on credit tenants, repayment guarantees, continued low cap rates and optimistic cash flow projections is not enough. A thorough understanding of the real estate can provide an additional buffer against risks – just in case.
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To download MBA’s full report on the state of the mortgage market, see here: https://www.mba.org/mail-to-forms/quaterlydatabook/2q15quarterlydatabook-form