Real Estate Finance Truth and Myths
By Jerry Glynn
The real estate finance industry has been subjected to a lot of beliefs over the years, many of them grounded in fact, with some being nothing more than conjecture. The theories that are more logical tend to be based on certain real factors that influence the real estate market and risk pricing. There are however, many other risk models and decisions that are based on assumptions that are less than credible. Learning which of these myths to believe in and which ones to discard is important to making solid decisions with regard to real estate finance. A few of the most common myths and the truth behind them are detailed below.
Real estate equity is a good option for investors. While there is no denying that well-placed real estate is a good investment option in the long run, the short and medium term prospects are less than optimal. Thinking that the current valuations will hold over the next few years is a risky move at best. It is true that real estate values in the U.S. have held in most markets due to a combination of factors, but this period of growth is bound to end at some point or another.
Mortgage debt is a solid investment option for real estate finance. Lower leverage loans are admittedly in a healthy state currently, but higher leverage mortgages are another story entirely. One of the most commonly heard terms in the real estate industry nowadays is debt cap rate. This generally refers to the mortgage value as an indicator of the cash flow. In most cases however, the debt cap rate is an indicator of a loan amount that is considerably higher than what the property in question would have gone for a few years ago.
Liquidity will continue to hold for the indefinite future. Many people who are into real estate finance assume that debt and equity capital will continue to be available for a long time to come. The fact is however that the real estate industry has seen longer periods of scarce liquidity. Such was the case in the period between 1990 and 1993.
It is true though that the real estate industry is a lot more robust today than it was in 1988-1989. This makes the chances of liquidity becoming unavailable in the immediate future a bit unlikely. Nevertheless, it is expected that there will be a lot less available credit in the next several years, particularly for leveraged transactions. Keep in mind that refinance risk for loans applied for today is much higher than it has been since 1986-1989. This is the case with leveraged fixed rates as well as with interest-only floating rates.
Interest rates are on the rise or will be soon. While many in the real estate finance business have been predicting this for a while now, this is not likely to happen soon. Fact is that in order for this to happen, there has to be a growth in the U.S. economy driven by a corresponding growth in gross domestic product, an occurrence that has still yet to be experienced.
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