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REAL ESTATE MERCHANT BANKING
As we near the end of the first quarter, it’s been quite an eventful start to the year on every level of the economy and the commercial real estate sector.
On the national and international level the unexpectedly frantic pace of the Trump administration’s changes are having an immediate impact on the CRE sector. DOGE and its government workforce reduction efforts have impacted both the residential and commercial office markets. However, as the cost cutting effort continues, expect a wide range of sectors, ranging from non-profits, consulting firms, universities, and defense firms to feel the impact and adjust their use or need for commercial real estate space. In essence, any business that relies on non-legislated Government funding could be affected.
Source: Trepp.com, GSA lease concentration across the US.
The uncertainty around tariffs is having immediate impact on development costs. General contractors are adding language in their contracts that will allow for material cost escalations resulting from tariffs in GMAX contracts. This added uncertainty will ultimately result in equity investors (and developers) seeing a higher yield on cost to compensate for the added risk. Achieving the targeted, untrended yields on cost in the 6.25% to 6.5% range for multifamily already has been a challenge for developers prior to the tariff discussions, Now with the added tariffs premium, we will likely see development activity slow down even further.
On a more positive note, as capital markets are trying to absorb the flurry of changes and assess the impact to the US economy, there has been a flight to safety which has pushed down the yield on the 5 and 10-year treasuries by 31 and 54 basis points respectively (as of March 12th) since the beginning of the year. In addition, we have seen a tightening of credit spreads on fixed rate financing as liquidity in the market remains high and deal volume continues it’s slow recovery. All are a good things for the CRE sector as borrowers are again seeing fixed rate interest rates as low as 5%.
Lastly, the Banks are once again lending and having positive impact on construction capital and bridge lending. Loan-to-cost on non-recourse construction debt is back above 60% LTC and creeping toward 65%. Debt funds are sourcing more aggressive terms on their warehouse lines, enabling them to reduce credit spreads on bridge loans to the high 100’s while maintaining underwriting discipline.
As we look forward, it’s safe to say that we’ll see continued volatility and uncertainty that should present investors and developers alike some interesting buying opportunities