A CREF renaissance.

Author:Woodwell, Jamie

Property values are nearly back to their 2007 levels. Property incomes exceed their 2007 levels. Mortgage originators are competing for loans. [paragraph] It's official. Commercial real estate finance markets are back. To be fair, the rebirth began in earnest in 2012 and was in the offing in 2011, but the full body of the market has only firmly reemerged in the last few quarters. [paragraph] This renaissance has been made possible by climbing property incomes, rebounding property values and still-low mortgage rates. The strength of the rebound is evidenced by mortgage origination levels

Property income

Slow but steady growth in the U.S. economy has rejuvenated commercial real estate markets. Vacancy rates are coming down, rents are going up and incomes are strengthening.

Increasing economic activity has raised demand for commercial real estate space across property types. Office vacancy rates have ticked down consistently, if slowly, in recent quar-ters--to 16.9 percent during the third quarter of 2013 from 17.6 percent at the end of 2010, according to Reis Inc., New York.

Retail vacancies are down to 10.5 percent from a high of 11.1 percent. Multifamily vacancy rates, benefiting from the move away from homeownership, are leading all property types with vacancies that have fallen to just 4.2 percent from a recession high of 8 percent.

The improvements in operating conditions have helped properties' bottom lines. According to data from the Chicago- based National Council of Real Estate Investment Fiduciaries (NCREIF), net operating incomes (NOIs) at industrial proper-ties--the laggard when it comes to income growth--have risen 4.2 percent from their recession lows and now sit 9.5 percent below their pre-recession high (see Figure 1).

Office property NOIs have risen 4.8 percent since hitting a recession low in the fourth quarter of 2011 and are now just 1.5 percent below their pre-recession high.

Most strikingly, average net operating incomes at apartment and retail properties have never been higher.

If one compares today's net operating incomes with what they were 10 years ago--when many of the loans that are now being refinanced were originated--industrial NOIs are 0.2 percent lower but office NOIs are 8 percent higher, retail NOIs are 24 percent higher and apartment NOIs are 59 percent higher.

NOIs are higher today than they have been at any time in the last 10 years for apartment and retail properties and--except for a brief period in 2009 and 2010--for office properties as well.

Given how low interest rates have been, property incomes--and a property's ratio of income to debt payments (or debt-service coverage ratio, DSCR)--have generally not been a significant barrier to financings. Even so, strong NOIs mean greater financeability for commercial and multifamily properties.

And as NOIs continue to rise, the ability of commercial properties to meet underwriting hurdles should continue to improve.

This is especially true for office properties which, 10 years ago, were experiencing NOI declines associated with the bursting of the dot-corn bubble. The fact that office NOIs fell 15 percent between 2001 and 2006 will mean that in coming years, 10-year growth in NOIs (e.g., NOI growth between 2004 and 2014 or NOI growth between 2005 and 2015) at those properties will get an added boost.

Collateral value

Even more central to the renaissance of commercial real estate finance...

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