Sudden surge in values creates mixed bag for lenders.

Following a volatile decade of real estate investment trends, described as "crazy" in the 1980's and depressed in the early 1990's, optimism and caution are called for as the industry prepares to move into the new millennium.

In the real estate debt markets, the end of 1994 through the beginning of 1995 brought dramatic cycle compression. Yield spreads, which peaked at approximately 250 to 350 basis points over comparable treasuries in 1993, were squashed to an average of less than 150 basis points by the beginning of 1995. and are expected to continue to decline to an average of 100 basis points during this year.

At the same time, the real estate equity markets continue to climb, as values rise in hand with a strong influx of capital. Also, despite talk that the commercial mortgage backed securities (CMBS) market would disappear, the transaction pipeline is jammed with approximately four to five billion dollars (the largest backlog in over five years). Interest remains high, although many deals were postponed to the first quarter of 1996. In fact, recent data indicates that heavy year-end closures boosted '95 over $18 billion - coming close to the $20 billion charted for '94 - because of lower than expected interest rates and a hope that rates will rise this year.

The dramatic cycle compression that occurred over the last 18 months and the sudden strength of equity markets has created a mixed-blessing for lenders and borrowers. Investors ought to be concerned with the rapid turnaround, but still aware that there is plenty of real estate-related investment opportunity out there. You'll have to dig harder to find it, but the value is still there.

Institutional investors have been extremely active in real estate investment for the last two years. Beginning in 1993, insurance companies came back. In mid 1994, both poured money into debt market transactions, hoping to achieve the yields they saw for investment grade mortgages. Some did, but most did not.

Debt has begun to look more like a commodity type market. There is still a significant amount of money - too much, in fact and yields are still under pressure, so spreads remain thin. To prove this out, you can look to the major players who have been active in the debt market, including insurance companies like TIM, Northwestern Mutual, Principal Financial and Prudential; banking institutions such as Citicorp, Sun Bank, Nations Bank; and credit companies such as Heller and GECC.

Unlike yield compression in the debt market, equity markets saw values begin to rise in 1994. Values continued to climb during 1995 and are expected to escalate in this year, depending on the product type. Money is pouring into this market, predominantly from pension funds, and values are increasing rapidly. We'll see a flurry of equity transactions at the end of the year, with apartments and suburban office and some types of retail product accounting for the majority of interest. We even see many hotels and CBD office beginning to find itself into the sales cycle.

There will be a lot of individual property transactions, a few mini-bulks with values in the $100 million to $250 million range, and quite a bit of product being securitized. Apartments had been the first and fastest product to ride a boom in values over the last 18 months, but values might be hard to find in this product type since the upside is quite limited. Conversely, high quality suburban office product remains appealing. National forecast figures show suburban vacancy rates dropping faster than CBD (central business district or urban) market counterparts.

Among the major equity players in 1995 were: General Growth (who bought Homart Properties), Ohio State, CALPERS, New York State Common Fund, Insignia and Summit Properties. Major funds that were also active in '95 include: Goldman Sachs, Morgan Stanley and Equitable.

Among the most interesting findings of the year is that the CMBS market is backed up, jammed with product that will not clear the pipeline until at least the first quarter of '96. There was a rapid increase in interest in this product type during the third and fourth quarter of '95 and the issues that were just getting on board at the end of the year did not have enough time to attract investor interest, or the yields that were proposed were not high enough - causing investors to wait and look for higher yields in '96. Therefore, many of these products are being pushed off until first or second quarter of '96."

Investor interest in CMBS transactions will remain high, supporting the planned early-1996 issues. Overall, interest is expected to remain high in real estate-related investment opportunities, as people are falling in love with real estate again.

While all indicators point to continued opportunity in real estate markets, there are some issues that may trouble investors:

* Underlying property economics should remain in the picture. All real estate transactions relate to the value of the property or properties in question. Real estate investment requires a property mentality versus a trading mentality.

* Spreads for certain product types may not justify the investment risk. When people are getting 35 percent returns in the stock market and 10 percent returns in real estate, the relative spreads may not justify the risk/reward portfolio concerns.

* The cycle compression may have occurred too rapidly for investors. When things turn around so quickly, generating a little frenzy in the market, investors may end up disappointed.

Real estate has never been an efficient market, yet it offers tremendous opportunity for investors, including banks, insurance companies and pension funds, through the end of the century. The markets seemingly turned on a dime in the last 18 months. After the crazy 1980's and the depressed early 1990's, we now see a blossoming love for real estate once again.