Real estate investors have long made the most of a red-hot market for commercial mortgage-backed securities. As with leveraged loans for the private equity industry, lax lending standards have underpinned cheap financing on transactions where debt sometimes tops 90 per cent of a deal’s value. Now that market has seized up, particularly for private buyers who require aggressive debt structures to compete for high-priced assets. The number of deals under contract that has been called off, delayed or re-priced has spiked.
Borrowing terms on a typical US commercial mortgage have risen to about 6.3 per cent from 5.5 per cent earlier this year, based on recent purchases. Blackstone flipped many of the assets from its Equity Office Properties purchase just in time, but more than $50bn of deals remain in the real estate industry’s pipeline. All eyes have now turned to Tishman Speyer and Lehman Brothers’ planned $22.2bn takeover of Archstone-Smith, an apartment specialist, set to close in October.
Tighter lending standards, which could cap debt at two-thirds of deal value and raise rates for certain buyers and assets, will crimp the flexibility of leveraged private buyers. Pricing power should swing back toward cash-rich institutions, rapidly growing sovereign equity funds and publicly traded real estate investment trusts, all of which use more conservative financing. Property prices have not yet flagged, and those buyers should help avoid a meltdown. But with equity Reits trading at a steep discount to net asset values – share prices are down 20 per cent since the EOP deal closed in February – the expectation must be that commercial real estate prices will begin to fall.