When considering what capital markets will have in store for us in 2013, it is important to note that the Greater Boston market gets to play from a slightly different set of rules than most other markets in the United States. It is glaringly obvious to many of us that the regional economy is robust: 5.5 percent unemployment, job growth in high-octane sectors, some of the highest income per capita in the country and, contrary to urban legend, population growth in urban areas. To be sure, cost of living will be an ongoing concern for our market, but a multitude of positive trends will more than offset any “brain drain” for the near term.
How does this translate into a capital markets outlook for commercial real estate? We can start with Boston’s ranking in the top three for institutional investors and top four for foreign investors. Some might argue that greater Boston is a top-two market in the United States. Perhaps our only real weakness is our size – we simply do not have enough core-quality assets to sell, finance or recapitalize to meet the needs of the institutional market.
The result? Bidding wars for the few high-quality real estate assets on the market for sale, and a highly competitive feedback matrix for assets seeking new debt financing.
In order to meet some of the pent-up demand for capital, investors seeking to invest in greater Boston will need to look in some of our softer submarkets, pursue development opportunities, or simply overpay for assets, if they haven’t already. Therefore, we will keep an eye on a few themes for 2013: Interest rates, maturing loans and development.
Interest Rates ‘Creeping Up’
At the end of 2011, few might have expected that the interest rate environment would continue to trend in favor of borrowers. Last year proved many of us wrong, with a 10-year Treasury rate reaching lows approaching 1.4 percent in the middle of the year.
Interest rates have been creeping up since, responding to improvements in equities markets and market chatter about a bubble in bond markets. The rise appears unlikely to be abated by anything other than a major systemic shock. We might expect spreads to compress as lending markets get more efficient and more risk-tolerant, in turn easing the pain of rising interest rates. To be sure, if rates rise too quickly, transaction volume may decelerate unless offset by a rapid improvement in fundamentals.
Refinancing Solutions In Sight
Over the last few years, many pundits expressed concern about how we were going to refinance this “wave” of maturing commercial mortgage-backed security (CMBS) and bank debt. Ironically, CMBS “2.1” may be the solution for refinancing CMBS “1.0.” With more than $13 billion in scheduled CMBS maturities for 2013, plus an undefined amount from recent CMBS restructures, the volume is not as daunting as we initially thought.
Banks hold more than $500 billion in commercial construction loans nationwide, much of which they will be capable of refinancing on their own. In 2012, CMBS originated nearly $50 billion; agencies another $50 billion and life companies potentially $50 billion more. Bank originations are more difficult to peg, but given recovery in values and proliferation of mezzanine and bridge lenders, there should be sufficient capital to satisfy this wave of maturities with manageable distress.
Urban Is In
If we could build an endless supply of apartment units with no adverse effect, we might just continue to build luxury multi-housing properties. However, other product types require some attention, and a dearth of buying opportunities for existing core product is steering capital in another direction.
This economic cycle is bringing clarity to some of the trends that will drive development for Greater Boston in the years to come. In retail, the “big box” is shrinking – Staples, for example – and becoming more urban in nature – such as Target and Assembly Row. Projects such as Samuels & Associates’ Boylston West demonstrate the positive impact of an urbanizing retail brand. Urbanization is not exclusive to retailers – there is a clear migration of office tenants moving from suburban locations to highly efficient office space in core downtown locations, such as Converse. Hotels continue to show healthy improvement in operating metrics, and an imminent convention center expansion will increase room demand substantially.
Spec Projects Possible
If these trends continue unabated, along with great fundamentals, demand should be sufficient to drive rents to the point where dynamic new projects will start construction on a speculative basis in 2013. New projects will seek to attract fast-growing companies into collaborative and efficient space, and newly minted urban footprints for retailers. Large, well-capitalized ownership groups including Skanska, Mass Mutual, Boston Properties and Carpenter & Co. that control large development sites won’t sit on their capital for very long.
To be sure, the global economy is still fragile. Any major systemic shocks could seize new development or capital markets, not necessarily in that order. Any potential transaction flow or new development in 2013 will need readily available capital to maintain positive momentum. The outlook for greater Boston is rosy by comparison, but a stronger global recovery in the short term will be critical to ensure the long-term sustainability of this cycle.
Carlos Febres-Mazzei is senior vice president with CBRE/New England’s capital markets team, specializing in debt and equity finance, and an advisory board member of the Urban Land Institute Boston. Email: carlos.febres@cbre-ne.com
