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Lending environment remains favorable for office investors.

Spreads for office properties are expected to remain attractive this year, as a pool of willing lenders continues to make capital readily available for owners and investors.

Projected NOI gains for office assets are reducing financing risks for lenders. Additionally, greater securitization of loans through CDOs and CMBS is creating a competitive lending climate.

Still, borrowers will want to take note of trends that could develop by year's end. For one, distinctions based on asset quality will become increasingly significant as the year progresses.

While pricing is expected to remain attractive, spreads on lower-tier assets are forecast to widen in response to slower economic growth and increasing speculative building.

Also, lenders may feel increased pressure from regulators this year as concerns regarding exposure to commercial real estate intensifies. In 2006, the Federal Reserve and FDIC warned that the concentration of commercial real estate loans had reached record highs and proposed guidelines to small lenders about overexposure to commercial properties.

As 2007 began, loans on office properties of $5 million and more, with debt-service coverage of 1.15x to 1.25x, were being written at 95 to 120 basis points over the 10-year U.S. Treasury. Smaller loans were pricing at 120 to 155 basis points over with DSCs pushing out to 1.2x to 1.3x. Strong capital flows into commercial real estate, combined with still-low interest rates, will keep financing costs at relatively low levels this year. Barring an unexpected spike in inflation, the yield on the 10-year U.S. Treasury is forecast to remain in the high-4 percent to low-5 percent range this year. While risks are still present, cooling economic conditions are expected to keep inflation levels moderate.

Overall, market indicators continue to support a relatively favorable interest rate outlook for the remainder of 2007.

Stabilizing Rates: The Fed is expected to remain in "wait-and-see" mode through the first half of 2007, given the housing market does not become a greater-than-expected drag on growth. Long-term rates are expected to remain in the 4.75 percent to 5.25 percent range through year end.

Conduits to Remain Active.: CMBS issuance is expected to remain strong as global investors continue to seek portfolio diversification through exposure to real estate. High-yielding mortgage bonds are especially sought after. As a result of concerns regarding underwriting standards among the major ratings agencies, current yield expectations of B-piece buyers and the large amount of CMBS issuance going to market through June, we have seen a pullback from CMBS issuers resulting in spreads widening by 10 to 20 basis points on average.

Leverage levels have been reduced because of concern over maintaining minimum property cash flows and debt service coverage. The CMBS market, while in a period of uncertainty, is trying to correct itself. But we are not sure how long that will take. June will most certainly be an interesting month as the market consumes $60 billion in CMBS overhang.

International Influence: Shifts in foreign capital flows may cause interest rate volatility this year. More than half of long-term U.S. Treasuries are held by overseas governments and investors, and their preference toward alternative investments is likely to cause additional swings in long-term rates.

Fundamentals Attracting Lenders: Improving office market fundamentals are resulting in robust revenue gains, which have pushed prices for office properties to new highs. Forecasts for the office market remain strong, reducing risks of distress sales and causing lenders to view office assets as a preferred property class.

Quality Distinctions Emerging: Lenders will continue to make capital available for office acquisitions, though further economic cooling could result in wider spreads for lower-quality properties, or those in less desirable locations or markets.

By WILLIAM E. HUGHES, SENIOR VICE PRESIDENT,

MARCUS & MILLICHAP CAPITAL CORP.
COPYRIGHT 2007 Hagedorn Publication
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Comment:Lending environment remains favorable for office investors.
Author:Hughes, William E.
Publication:Real Estate Weekly
Date:Jun 13, 2007
Words:622
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