Real Estate Credit Environment:
Risk Off - Risk On

Earlier last year real estate markets received a scare as CMBS spreads widened, particularly in lower rated and more junior tranches.  Additionally, one of the most respected U.S. real estate research firms predicted outright price declines for the asset class in 2016.  While credit conditions have tightened, particularly for construction financing, wider scale credit concerns have largely dissipated and CMBS spreads have tightened. Further, price declines for private real estate, in aggregate, did not materialize and private real estate returns are poised to be amongst the best of all asset classes in 2016.

ch1-re-blog

While recent CMBS spreads indicate a return to normalcy, managers continue to report a tighter market with slightly higher financing spreads and more difficulty in obtaining construction financing.  Further, credit markets are an important indicator of stress in underlying markets especially for real estate.  Recent data from the Fed does indicate banks began tightening credit standards in the fourth quarter of 2015. This is the first extended period of net tightening since the recovery in real estate began five years ago.

ch2-re-blogWhile the magnitude of the tightening is clearly dwarfed by prior cycles, it’s important to consider the reasons behind changes to underwriting standards.  Pre- Global Financial Crisis (“GFC”) banks began tightening lending activity in response to decelerating and declining GDP growth while current tightening has been followed by positive and accelerating GDP growth.  Banks have cited declining economic conditions and industry specific factors in real estate (likely supply concerns) but these appear to be anticipatory concerns versus the reactionary response to conditions during the GFC. Further, a new widely-reported rationale also indicates some important differences.  Concerns over regulatory changes due to Dodd Frank and Basel III are new and more recent reasons cited in the Fed survey.  Banks, anticipating both a deteriorating backdrop for real estate and increased government regulation have become more disciplined during this cycle, which we believe is a positive for the asset class going forward.

ch3-re-blogThe net effect of recent tightening of lending activity has been felt most acutely in construction financing.  While certain sectors have experienced significant increases in supply, particularly multi-family, non-residential construction as a percentage of GDP remains below its historical average. Building as a percent of GDP stands at 2.7 percent versus the 70 year historical average of 3.5 percent and well below peaks experienced in early 1990’s and 2008.  Thus, while we are not experiencing the lack of supply of the last few years, we are likely not in an oversupplied market as well. 

We believe this economic cycle is likely to continue for some time and the credit environment will continue to provide a positive backdrop for real estate investors.  However, the easy returns have been made as cap rate declines are likely complete and rising interest rates will become a headwind for the asset class.  At Commonfund we believe investors should focus on less interest rate sensitive sectors of the asset class, strategies with positive demographic tailwinds and managers with a unique skill or where value creation is the primary driver of return.

Authors

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Paul M. Von Steenburg is responsible for custom solutions for Commonfund OCIO clients. He is primarily responsible for asset allocation recommendations, portfolio oversight and tactical rebalancing of client portfolios. Paul is also a senior member of the Investment Team with specific responsibility for overseeing real asset strategies and private real estate investments.  Prior to joining Commonfund in 2007, Paul was a Vice President of Wilshire Associates where he advised institutional investors on asset allocation, portfolio construction and manager selection and was Chair of Wilshire′s Hedge Fund Committee. Prior to Wilshire, Paul worked in equity research for Waddell & Reed Asset Management with a specific focus on technology services companies. Paul also spent five years with the Instinet Group as Manager of the Global Correspondent Trading Group. Paul received his B.S. from Rutgers University and M.B.A. in Finance from Cornell University. Paul also holds the Chartered Financial Analyst and Chartered Alternative Investment Analyst designations and is a member of the investment committee for the Save the Children Foundation.
Paul Von Steenburg
Managing Director, CFA, CAIA

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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund managers. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund managers. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.