As I begin a new calendar year, I think of the Amazing Kreskin, who for some six decades has served as a bona fide mentalist with his predictions for the coming year. Instead of seeking advice from someone unfamiliar with the world of commercial and residential real estate, I asked real estate leaders for insight on 2017.
The Federal Reserve has implemented a rate increase, and the pricing of the 10-year Treasury note has nearly doubled since the election. Rising interest rates have a direct effect on the pricing of mortgage financing for commercial real estate. While lenders are cautiously optimistic about the environment for financing, real estate owners and developers are worried about the availability of financing this year.
“For 2017, I think the story will be interest rates and exchange rates,” said Francis Greenburger, the chief executive officer of Time Equities. “As the U.S. dollar gains in relative value, New York becomes more expensive for tourists and U.S. exports become more expensive. These will both be drags on the economy and a definite negative for New York and other locations regarding international travel.”
Larry Korman, the president of AKA Hotels and co-CEO of Korman Communities, concurs: “Higher interest rates, spurred partially by inflationary Trump expectations are obviously a major problem for real estate. The effect will be particularly pronounced on lower cap rates where loan-to-values will be more constrained due to coverage requirements.”
Joshua Muss, the chairman of Muss Development, said, “The fear of rising rates could actually goose real estate activity over the next year, or years, as developers and purchasers rush to complete transactions, while interest rates remain affordable. However, will the banks and other investors hold back and effectively stifle the market by not wanting to push out cash before they can cash in on newly rising rates?”
“One has to be cognizant of the downside risks to pricing that rising rates will have,” said Paulo Garcia, the senior vice president and New York commercial real estate manager at Mercantil Commercebank. “Lenders must underwrite real estate values very carefully in a period of rising rates. The local economy continues to be dynamic, resilient and vibrant, and we feel lucky to be part of lending in this market.”
This will likely be an interesting year for both banks and commercial real estate borrowers, said Kevin Cummings, the president and CEO of Investors Bank. “Confidence in the president-elect and his programs are currently running very high, but the global economy is still fragile and exposed to geopolitical shocks.”
Indeed, industry participants are keeping watchful eyes on the president-elect as they assess the year ahead.
Chad Tredway, the managing director and the head of the east region for Chase Commercial Term Lending, said that with a new president, rising interest rates and changing reforms, “we see 2017 as a year of volatility. The market is at an inflection point, and borrowers and banks will need to be flexible depending on the outcomes. As the cycle continues, it’s important to ask what will affect your cash flow. As interest rates rise, borrowers should not overleverage. If a 100-basis-point increase in interest rates makes or breaks a deal, it may not be the right deal. We also believe volatility could create additional opportunities for purchases as many of our clients are building reserves to be opportunistic as the markets change.”
Even before the presidential election, the number of lenders interested in providing financing for the hospitality sector was few. Commercial banks will continue to provide construction financing at levels of a maximum of 50 to 60 percent of the cost of a development. Pricing is expected to continue to rise, and so hotel developers seeking higher levels of financing will be seeking out private equity funds, private investors, mezzanine financing and preferred equity.
As many lenders explained, the bank is getting paid for the risk of construction financing. The head of a New York City money center bank, who prefers to remain anonymous, said, “We plan to reduce our overall exposure to construction financing of all product types. The economics of such deals continues to be challenging, so expect to see a lower number of banks providing construction financing in 2017.”
Ultimately, “Anyone who pretends to know what 2017 holds in store for us is either truly psychic or delusional,” said Seth Pinsky, the executive vice president and investment manager at RXR Realty. “The best advice for the new year is to stay optimistic but be prepared for the unexpected. As we have learned in recent years, though our country and especially our city remain strong and resilient, the seemingly impossible can and does happen.”
Michael Stoler is a managing director at Madison Realty Capital and is the host of the Stoler Report-New York’s Business Report.