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The Real Estate Capital Scoreboard – April 2008


Chicago, Illinois, April 1, 2008 – “March Madness” defines current realty capital markets. While treasury rates barely changed (about 10 basis points), lenders exercise extreme caution in a fog of doubt.

Even as rates remain near historical lows, borrowers are baffled by substantially less favorable lending programs including wider spreads, rate floors and overall lower leverage. In particular, mortgage pricing is one of the key misunderstood variables for sizing loans today. A brief review and update on mortgage pricing are as follows:

• Swap Spread Pricing – Lenders favor swap spreads their movements account for treasury spread volatility. Pricing is protected from unpredictable spread gyrations as was the case much of last year. For example, a minimum spreads of in excess of 200 basis points plus a ten-year treasury yields translate to longer-term rates of 6.30% or more.

• “Baseline” Pricing - Obtaining the most competitive quotes in the marketplace normally requires calling various lenders and collecting the best quotes. Although this process is still common, lenders readily determine most attractive, risk-free realty debt pricing by checking with the commercial-mortgage securities markets. Today, the highest quality, commercial mortgage securities (e.g., 10 Yr AAA CMBS issues), trade in excess of 6.5% -- the new benchmark for lender rate floors.

• Balance-Sheet Pricing - While Swap-Spread and Baseline pricing models are popular, many funding sources rely on balance-sheet metrics for pricing permanent debt including banks, life companies and agencies. Each of these sources have cost-of-funds that aren’t necesssarily indexed to bond markets or treasuries. The Agencies, for example, are able to provide pricing below 6% for longer-term debt – well below traditional sources of capital.

Several changes are on the horizon with respect to various pricing formats including:

• More Conservative Underwriting - while interest rates are relatively attractive, continued pressure on funding proceeds will drive lower leverage levels.
• Narrowing Spreads and Pricing - as bond markets gain more stability, narrower spreads are expected.
• Wider Band of Pricing - within recent years, various types of properties (e.g., lodging, multifamily, retail) were priced within a narrow range. As markets readjust, lenders will expect greater pricing premiums for different property risk profiles.

More discipline will continue to drive debt pricing and capital market recovery. Dr. Timothy Riddiough, an Editorial Advisory Group member of the Real Estate Capital Institute, suggests the long-term solution for improving capital market malise is “to educate and protect the demand side by encouraging moderation and safer practices.”


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