Rising interest rates and a new wariness by lenders have slowed the US buying spree in commercial

Rising interest rates and a new wariness by lenders have slowed the US buying spree in commercial real estate, leaving some property experts to suggest the sector’s multi-year run may be over.

While currency-strong foreign buyers and real estate investment trusts (Reits) may yet enter the market, private equity firms and property tycoons facing the new lending environment are pulling back.

‘The total landscape has changed and the days of borrowers making a phone call to a particular bank and getting 90 percent financing is really not happening anymore,’ said Howard Michaels, founder and chairman of Carlton Group, which helps buyers finance their deals.

US borrowers have been hit with a one-two punch in just the last few weeks. First, the lending market, which heavily relies on buyers of commercial mortgage-backed securities, created from slicing and dicing pools of mortgages, have begun to reject pools containing risky mortgages. Rating agencies have chimed in with demands for more safety for the highest-rated bonds.

On top of that, yields on the 10-year Treasury note, which influence mortgage rates, have jumped as much as 0.37 percentage points in a week from 4.96 per cent to 5.33 per cent on June 13 and were 5.15 on Monday, making the cost of borrowing and buying property more expensive.

That is a dramatic shift from the last several years when private equity buyers, such as the Blackstone Group, snatched up billions of dollars worth of real estate by accessing the commercial mortgage-backed securities markets and other sources to finance their deals.

They justified the prices because they have been able to sell their buildings relatively quickly at higher values. But those values could start to slide as higher interest rates push up capitalisation rates - the initial yield investors make on their property. Just like a bond, higher yields mean lower prices.

‘We are starting to see a modest increase in cap rates,’ Mr Michaels said. Last week, Stifel Nicolaus analyst David Fick lowered his rating the Reit sector to a ‘negative bias’, after he spoke to some of those people who funded Blackstone’s largest deals.

‘What we were hearing is that many of the transactions that had occurred would not have been able to happen today based on the revised interest rate assumptions as well as tightening credit due to the rating agencies’ changing stance,’ he said.

In the latest big deal, debt costs prompted Tishman Speyer and Lehman Brothers to lower their bid for apartment Reit Archstone-Smith Trust to US$60.75 from the originally proposed US$64 per share.

While the current environment may ease the pace of buying US commercial real estate among the major US players, don’t expect a tumble like the US housing market.

The turmoil in the residential subprime market spooked the commercial lending market, prompting commercial standards to tighten before a crisis emerged.

‘The subprime issue asked the question: Have you thought about what is inside the pools that you’re buying?’ said Leonard Cotton, vice-chairman of Centerline Capital Group, a unit of Centerline Holding Co, and president of the Commercial Mortgage Securities Association.

More importantly, the commercial real estate market has not experienced an oversupply of buildings, as in past downturns. ‘What we have today verses the 70s and 80s is very few overbuilt markets,’ Mr Cotton said. ‘Now we have a lot of office buildings in New York that people overpaid for that are full.’

On the demand side, tighter lending standards may also help real estate investment trusts, who have been outbid by private buyers, and foreign buyers armed with valuable currency could step in to help support the market.

John Kriz, managing director of Moody’s Real Estate Finance, said at a real estate investors conference in early June that Reits could shine as buyers because they have good credit and do not rely as much on debt to finance their transactions.

Foreign buyers may also become a force, said Marjorie Tsang, assistant deputy controller of the New York State Common Retirement Fund, which has US$154.5 billion of assets under management.

‘I get an e-mail or phone call every single week from major investors that are the equivalent of our pension fund in Japan, in Germany, in Canada and everyone is looking to see how they can get into the United States in a big way,’ she said. ‘Not sticking their toe in, but in a big way.’

Source: The Business Times, 20 June 2007