Sometimes good news for commercial real estate is bad news for global investors. High real estate values and low interest rates for all types of real estate financing—especially in the core real estate markets the global real estate investors favor—continues to push returns on investment lower.
“The low level of absolute yield is something that investors are struggling with all over the world,” said Goh Kok Huat, COO and president, GIC Real Estate, investing for the government of Singapore, speaking at the Urban Land Institute’s annual meeting held in New York City, October 21-23.
Low, low yields
Real estate in the U.S. is especially attractive, despite the low yields and the high cost of U.S. taxes imposed on foreign investment, such as the Foreign Investment in Real Property Tax Act.
“We price every country according to risk embedded in the country,” said Goh. “Relative to other asset classes, yields are not that low.” Real estate in U.S. is perceived as less risky, especially compared alternatives such as real estate in Hong Kong, where pro-democracy protesters recently shut down the central city, or real estate in Europe, which is shadowed by possibility of deflation.
Yields on U.S. real estate are likely to return to historical norms eventually, however the panel did not expects yields to rise anytime soon. As Europe wavers on the brink of yet another downturn, interest rates overall are likely to stay low as European central bankers consider monetary policies, such as quantitative easing, that could push rates even lower. In addition, yields on real estate investments are substantially higher than yields on the benchmark government bonds. So it’s conceivable that real estate yields could drop even further, driving prices higher and interest rates lower.
Financing is very available
Permanent loans have been easily available for stabilized assets for some time. Now mezzanine and construction financing are also relatedly easy to get.
Even mezzanine loans are now available at low interest rates. “For stabilized assets, the return on debt has really tightened up,” said Related Companies CEO Jeff T. Blau. “The compression in return over the last 18 months is pretty significant.”
For mezzanine loans that cover up to 80 percent of the value of a stabilized property when added to a primary loan, lenders typically charge interest rates of 800 to 900 basis points. To generate higher yields, lenders like Related focus on areas like mezzanine financing to construction projects and value-added investments. “For non-cash-flowing assets, our return requirements are in the double digits,” said Blau.
Construction loans are also available for good projects. “Construction financing has come back pretty significantly, though lenders are much more conscious of sponsorship and location,” says Blau. Mid-sized construction loans are very available from a variety of commercial banks, especially for properties located in major property markets. “You can arrange that pretty quickly,” says Blau.
Larger loans, above $200 million in size, are more difficult and may require multiple lenders. “It’s almost impossible to arrange that with a single commercial bank,” says Blau. “That is a real opportunity for lenders that have the balance sheet.”