CIT’s Galligan: Prepare for Coming Regulations
Commercial real estate is seeing ample capital, low cap rates and high valuations at the moment, but coming regulations could change that, said CIT Real Estate Finance President Matt Galligan.
Galligan said commercial mortgage-backed securities issuers are bracing for two new regulations that will take effect in the fourth quarter. “One is called risk retention, where underwriters are required to retain part of the risk as they sell CMBS bonds into the secondary market,” he said. “It’s a new concept and it came out of the 2008 era, where players sold off obligations, leaving the buyer with all the risk.”
The second new regulation requires senior individuals to literally sign off on the quality of the CMBS loan product, Galligan said.
“The market is struggling to interpret the specifics of these regulations, thus creating turmoil,” Galligan said. “As a result of a largely unknowable fourth quarter, many CMBS originators are clearing inventory in order to help divert any potential risk that may be exposed by these new regulations. That could siphon off a lot of the liquidity needed to refinance loans.”
Galligan also noted significantly different yields in major cities compared to smaller urban areas. “As interest rates begin to climb, the return on investment of a deal will take a notable dip,” he said. “With real estate opportunities found in a secondary or tertiary market, often the asset can be acquired at more favorable terms. He said a Class B multifamily garden apartment property in a market such as Pittsburgh, Pa., would likely trade at a 6 percent cap rate–a very reasonable valuation. “On the other hand, a Class A asset in northern New Jersey would trade around a 3.75 percent cap rate, a very high valuation. The right assets in secondary markets can be a very attractive place to invest. In any event, these deals and the banks involved need a liquid CMBS market to be repaid.”
On a positive note, Galligan called recent employment growth smooth and steady, “which is a great thing for real estate,” he said. “As long as there are only gradual increases in interest rates and continued modest increases in employment, the commercial real estate market should operate smoothly,” he said, noting that the U.S. real estate market remains one of the most attractive sectors in the world for any internationally sourced funds.
