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3 Things Debt Markets Worry About

The long growth cycle in San Francisco has many scratching their heads over whether to expect more improvement or to hunker down for a downturn. San Francisco is in its seventh year of expansion and many expect something to change soon.

Partner Engineering and Science national client manager Jay Grenfell, STRS Ohio acquisition director Eric Newberg, Four Corners Properties founder Bruce Burkard and HFF managing director Peter Smyslowski

With the development cycle feeling full and construction financing near impossible, many capital markets are becoming less aggressive. Partner Engineering and Science national client manager Jay Grenfell discussed with panelists during a recent Bisnow event how debt markets are faring and what could impact capital markets in the future.

Increased Caution

STRS Ohio Acquisition Director Eric Newberg

STRS Ohio acquisition director Eric Newberg said with oversupply in the market, his company worries about a pullback from venture capital. He said debt markets are drying up, which has led STRS Ohio to be more cautious about using its balance sheet.

Although STRS Ohio is typically a long-term-hold investor, it has been partnering with small groups where it can provide liquidity for short-term investments. STRS Ohio has been looking at two- to five-year holds. Newberg said this has been a successful strategy, but it takes a lot of work. Over the last three years, his company has seen a 25% return.

HFF managing director Peter Smyslowski said underwriting constraints are playing a bigger factor today than previously. He said lenders are not as aggressive in their underwriting metrics, are cautious about rent increases and are being firm in underwriting market vacancies.

Banks also are becoming even more cautious than before, according to Smyslowski. A year or 18 months ago, banks were not afraid to do a full underwrite on big deals. Now, they are concerned with having their participant banks lined up in advance of closing.

There has been general concern in San Francisco with how long we have been in an up cycle. Investors are anticipating something to happen at this point of the market, and a lot of uncertainty in the geopolitical environment could affect interest yields, according to Smyslowski.

State of Construction

HFF managing director Peter Smyslowski

Construction financing is among the biggest topics right now, Smyslowski said. About a year or two ago, construction loans were more favorable, and now there is a lot of concern and restraint from providers. Construction pricing has gone up, and Smyslowski expects some of the pipeline projects to undergo natural attrition due to a lack of financial providers. He said more specialty lenders are starting to jump in to provide multifamily loans, which were traditionally done by banks.

CMBS Issuance

Attendees at Bisnow's San Francisco Capital Markets event 2017

CMBS issuance continues to go down, but Smyslowski said this form of capital is an extremely important part of a well-functioning real estate market. It provides liquidity where other providers will not go.

A year ago there were 35 CMBS lenders and now there may be about 25 remaining. Smyslowski does not expect CMBS to reach anywhere near the $300B market set in 2007. He said in 2017, it will be hard to get even $100B.