Commercial Mortgages: Capital is flowing into real estate

Bono probably wasn't thinking about the rebirth of commercial real estate when he sang "After the flood all the colors came out" in U2's "Beautiful Day," but the song evokes the budding optimism that can be felt in the industry today.

After four tough years of battles with lenders, tenants and investors, commercial real estate developers seem poised to move beyond their recent past and look toward the future.

What is the reason for this outlook? In a word: capital.

Capital is the life blood of real estate. When it's flowing, the industry blossoms, and when it's not, the industry shrivels.

For the better part of four years, capital has been receding from real estate (and other assets); now it is flowing back in.

Bill Gross, the famed head of PIMCO, the world's largest bond investor, recently released an investment outlook that is a bit scary for investors because Gross predicts that real growth will be severely limited by excessive fiscal deficits and high debt-to-gross domestic product levels.

The good news: Investment real estate, in his view, is one asset class that has the potential to deliver the most return with the least amount of risk. The caveat is that the assets shouldn't be "burdened by excessive debt and subject to future haircuts."

Of course, savvy investors have already come to the same conclusion and have been running to so-called "fortress" commercial real estate for several years.

That is, they have been investing in the top buildings in the top markets and using low leverage in their purchases. The thinking is that as inflation kicks in, rents will go up and you will have good returns that are a hedge against inflation.

The only problem with the thinking is that when everyone is trying to buy the best building in the best cities in the country, it is hard to get a price that creates attractive returns.

No matter how attractive a building, every building has a price that is unattractive. That is why investors are now looking beyond "fortress" real estate and exploring secondary markets.

For instance, February sales volume fell year-over-year in Boston, Los Angeles, San Francisco and Washington, but rose in Chicago, Detroit and Seattle, according to research from CoStar Group, a Washington-based real estate information provider.

While one month is hardly a trend, it shows an expected progression in the recovery and has industry participants in smaller cities feeling more upbeat.

A huge help in this trend of capital turning to secondary markets is the availability of debt.
With commercial mortgage-backed security lenders more active and extending their success of the past few months, more money is flowing to a wider range of real estate.

Pricing for five- and 10-year mortgages is now in the 4 to 4.85 percent range, respectively, for solid non-recourse mortgages from life insurance companies and Wall Street conduits (commercial mortgage-backed security lenders), according to the John B. Levy & Co. National Mortgage survey.
Lower leverage deals are priced lower and smaller loans financed with community banks are priced higher.

Rates on commercial mortgages are higher this month than they were last month primarily because yields on U.S. Treasuries have increased significantly. This has occurred because investors have a little more faith in the economy and are willing to look elsewhere for higher returns.

The same is occurring in commercial real estate.

Investors are moving away from "fortress" real estate and into secondary markets to get better returns.
Richmond should be a direct beneficiary in this movement and has already benefited from an increase in debt capital availability.

The question is how long will prices remain attractive while debt remains cheap? As Bono would say, "It's a beautiful day, don't let it get away."

Andrew Little is an investment banker with John B. Levy & Co. He can be reached at alittle@jblevyco.com.

Article from http://www2.timesdispatch.com/business/2012/apr/09/tdmbiz06-commercial-mortgages-capital-is-flowing-i-ar-1827844/

Invest in assured returns projects at your own risk

You can’t miss the billboards, the full-page advertisements, the television commercials offering you a juicy 12% per annum “assured” return on an upcoming residential or a commercial project. At a time when equity is volatile and high inflation is reducing the real return on deposits, the offer of a 12% return on a long-term appreciating asset like real estate sounds too good to pass up. The golden rule of investing is to question any deal that looks too good to be true; it often is too good to be true.

How do assured returns schemes work?
You buy a property outright (even when the completion of the construction is two or three years away) with either your own funds or a loan from a bank. Say, you pay Rs1 crore for the flat. During the construction period, you get Rs1 lakh a month (12% per annum of Rs1 crore) through post-dated cheques the builder issues you.

Once you get the possession of the flat, you can either exit the project or continue with the agreement, but the terms could change as the property will be leased out to a tenant and the developer may share the rent with you. There is no lock-in period for the agreement; it is usually for the next two, three, five or 10 years after possession.

SOUNDS GREAT. BUT LET’S ASK SOME QUESTIONS
From where is the developer giving a 12% return?

When a deal looks so good, we need to begin asking questions. The yield from residential housing is usually in the band of 2-6%. That means the annual rent as a percentage of the capital value is about 4%. A Rs1 crore property should get you an annual rental of about Rs4 lakh a year or Rs33,000 a month. So how is it that the builder is offering you a return that is three times the rental? There is obviously some other story at play.
Data from Kotak Securities Ltd, a brokerage house, shows that absorption levels in projects have deteriorated and there is an increase in inventory across prime real estate markets.

The excess supply is making some developers less creditworthy in the eyes of the banks and private equity (PE) that traditionally fund the business. This is forcing developers to turn to various other funding options, such as getting hold of bank finance but routing it through you, the buyer, because you get the loan at much lower rates. Says Gulam Zia, national director (research and advisory services), Knight Frank India, a property consultant firm, “This is a measure taken in desperation to raise cheap money from investors and buyers. If the same developer looks for a financing option from banks, he would get the money at a high cost (at a rate of 14-15%). Thus for him, getting money for 10-12% means cheaper financing.”

What is the guarantee that the post-dated cheques will not bounce?

Says Omaxe Ltd’s spokesperson, “In the past, it has never happened that any cheque has bounced from any developer.” The company that is running the scheme at one of its commercial projects at Greater Noida accepts payment from buyers in the company’s account, he adds.
However, it is worth mentioning that banks sometimes lend money to real estate developers by creating an escrow account. The receivables from customers also come in this account. The deposits made in this is strictly meant for the construction of the particular project. Says Ramesh Nair, managing director (west), Jones Lang LaSalle India, an international property consultant firm, “There is no such mandatory rule for creating an escrow account. However, this has been discussed in the proposed real estate regulatory bill.”
So is there a regulator overseeing this promise?

Seems not. In an email response to our query, the spokesperson of Reserve Bank of India said, “We do not regulate real estate firms so I won’t be able to respond to the queries.”
Capital markets regulator, Securities and Exchange Board of India (Sebi), too, does not regulate real estate projects, but has regulatory oversight over the collective investment schemes around real estate like PE funds.

India does not have a real estate regulator in place as yet. So you are believing the good intentions of the developer and his ability to keep the promise of payment. Questions Anurag Mathur, managing director, Cushman and Wakefield India, an international property consultant firm: “These are basically non-secure schemes. If there is some default from the developers’ side, what is the recourse for investors in these schemes?”

Unless you are a speculator and have the money, legal help and stomach for such deals, stay away from the assured returns projects. They come in with very high-risk (almost 90% of the cost is paid upfront to the developer) and high-return category of assets. There is an investor for whom these will work, but if you are the average salary-earning and EMI-paying homebuyer, stay away.

Illustrations by Jayachandran/Mint

devesh@livemint.com

Article from http://www.livemint.com/2012/04/08205625/Invest-in-assured-returns-proj.html

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Taken from http://www.orato.com/business-career/why-you-ought-to-read-real-estate