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Page 14 — Office Properties Quarterly — June 2019 www.crej.com We’re an award-winning, full service property management company with more than 30 years of experience and 5.4 million square-feet in our commercial portfolio . We make it our business to manage yours. GriffisBlessing.com Colorado Springs 719.520.1234 Managing too much? We can help. Denver 303.771.0800 C M Y CM MY CY CMY K GB-OfficeBldg-CREJ120418-PRINTREADY.pdf 1 12/4/18 2:57 PM T he rollercoaster ride continues. Without fail, the current envi- ronment of the global capital markets continues to torment even the most-seasoned econ- omists who are trying to predict what course we will be on for the foresee- able future. At the time this article was written, the 10-year Treasury, a common benchmark for interest rates on commercial real estate loans, sat at 2.11%, the lowest it had been since September 2017. In September 2018, the 10-year Treasury was consistently north of 3% and most people in tune with the market predicted that this would be the new normal. For years, the widely accepted the- ory was that the United States econo- my would fall into some level of reces- sion as early as 2018 to 2020. As this prediction continues to get pushed further into the future, we may just be in for shorter periods of turbulence mixed in with calmer moments. Some of the news in the last six months has been greeted with open arms – for example, when Federal Reserve Chairman Jerome Powell declared that there would be no more rate hikes for the foreseeable future, citing the lack of inflation as the main reason. This has had a significant impact on short- term indexes, like 30-day Libor, which are most commonly used in three- to five-year floating-rate bridge loans. Whereas each Fed rate hike would inevitably signal a rise in the cor- responding Libor index, the forward curve has flattened with the anticipa- tion that rates may dip in late 2019 or early 2020. Commercial real estate lenders are navigating the current environment with care but also are cautious not to miss out on oppor- tunities due to the sheer amount of competition in the market. Life insur- ance companies have traditionally offered some of the most “borrower- friendly” debt due to their competitive pricing and hands- off structure. As treasuries rose in the first half of 2018 and then fell toward and into early 2019, life companies held spreads and cushioned the descent with interest rate floors as they quanti- fied their positions against corporate bond yields, a common benchmark for determining their interest rate spreads on commercial real estate loans. Commercial mortgage-backed securities or conduit lenders took the position to raise spreads as trea- sury and swap yields dove in order to maintain the coupons (mid-4% to low-5% range) that bond buyers had become accustomed to seeing in securitization pools. The number of debt funds, lenders who provide a bevy of options includ- ing senior bridge loans, mezzanine financing and preferred equity, have exploded over the last few years and have created an incredibly competi- tive alternative to traditional bank financing. These groups leverage their position to solve for an internal rate of return and typically seek second- ary financing from banks, foreign capital sources or via collateralized loan obligations, which is a form of securitization. A collateralized loan obligations issu- ance in late 2018 missed its pricing mark by 15-20 basis points, which put a temporary stall in that sector of the market. It was not long before debt funds re-emerged early in 2019 as the markets started to settle. Although there are a lack of value-add office deals in Denver relative to some other markets, debt funds have been active locally by competing on leverage and structure where the banks cannot. For “value-add light” or “core-plus” deals with a slight lift to stabilization, the debt funds are approaching bank pricing with some deals going off in the low 200s over 30-day Libor com- pared to banks pricing similar deals in the high 100s. The banks still are winning their fair share of business with rock-solid borrower relationships and competitive pricing. As everyone tries to assess how much runway this cycle has left, banks in particular are tightening their reins on their lend- ing guidelines and have continued to be conservative when underwriting transitional or ground-up construc- tion deals. The Denver office market continues to chug along with plentiful amounts of domestic and foreign capital pursu- ing the limited inventory of for-sale product at any given time. From a lending perspective, new construction and office buildings located in urban markets (downtown Denver, Cherry Creek, Boulder) are the most sought after, especially from life insurance companies and banks. Many of the new office properties benefit from the lengthy weighted-average lease term of their tenants, which match up nicely with longer-term life company loans that are designed to match their outstanding insurance products. On the other end of the spectrum, there still is strong demand for short-term loans with flexible prepayment penal- ties. Some buildings have traded two to three times since 2009 as the mar- ket continues to mature. For example, Union Station’s NorthWing building sold in March for $697 per sf, up from its $600 per sf price tag exactly five years prior; an appreciation in value purely dictated by the strong ongoing fundamentals of Denver’s Union Sta- tion submarket. The geopolitical climate likely will continue to create both opportunities and perils in the lending markets and will be subject to change on a weekly or monthly basis. On a positive note, the recent Treasury compression is producing consistent interest rate coupons in the high-3% to low-4% range, which still are historically low, even in this tight cap rate environ- ment. For those who do think we might see some level of a recession in the next couple of years, the ability to lock in this attractive long-term debt should help to bridge the gap between stronger markets and should cre- ate a buffer for owners if rental rates should soften. V The balancing act in financing office properties Market Insights Jeff Halsey Vice president, debt and structured finance, capital markets, CBRE Brady O’Donnell Vice chairman, debt and structured finance, capital markets, CBRE