Experts see range of effects from rate cut
Experts see range of effects from rate cut

By Richard Mize

Published: January 23, 2008

Psych!

That's the biggest impact the Federal Reserve's out-of-the-blue rate cut will have on property markets, Oklahoma City commercial realty specialists said Tuesday.

The Fed said it lowered its target for the federal funds rate 75 points to 3½ percent, "in view of a weakening of the economic outlook and increasing downside risks to growth,” indications of "a deepening of the housing contraction” and other looming specters of a national recession.

"That's huge. Psychologically, it's huge. It's going to have a huge impact,” said Tim Strange, managing director of Sperry Van Ness Commercial Real Estate Advisors.

Strange said he expected no loosening in the securitized credit markets — the high finance that backs much of everyday investment lending. Their problem isn't lack of money to lend, but fear of lending in the face of continued uncertainty, he said.

"I don't see those guys coming off of the sidelines for a while,” Strange said.

But the Fed's move could free up some local financing, said Brett Price, a broker with Sperry Van Ness.

"Our thoughts are it's not going to affect rates that much on construction loans, but it will affect liquidity,” Price said.

The prime rate, which banks charge their best customers, typically follows changes in the federal funds rate. That means the interest paid by existing commercial borrowers probably will drop as a result of the Fed's action.

A drop in the prime rate then makes borrowers' income-producing properties a little more profitable, which is where increased liquidity can be injected into a market, said Trevor Kelly, Tulsa-based Spirit Bank's Oklahoma City president.

A reduction in interest on payments for property with tenants paying set rents "goes to the bottom line,” Kelly said. Investors don't sit on money if they can use it, he said, so they'll go back to a lender and negotiate a way to "take that liquidity and put it back into the market.”

Ford Price, co-managing partner of Price Edwards & Co., said the surprise rate cut "is simply an effort to mollify the markets that everything is being done to deal with this situation. It will make it cheaper for banks to borrow money and deal with liquidity issues.”

However, the Fed action won't reverse the shifts the past few months in underwriting attitudes surrounding commercial real estate loans, he said.

"(Lenders) are getting more cautious. The interest-only loans are pretty much gone, so loan amortization from Day 1 is a requirement,” Price said. "Further, the debt service coverage ratio, the difference between net operating income and the actual annual debt service, is moving back up ...

"The other lender dynamic is that loan-to-value ratios are going back up. Previously, some lenders would lend 90 percent of the value, as determined by an appraisal, which means the borrower could buy a property for not much equity and increase his leveraged returns.”

Appraisals, he said, based on "an imprecise science to begin with” themselves are in flux.

"When times are good, people underwrite income streams with rose-colored glasses and assume that rents will only increase over time, which leads to high appraisals, since those future income streams are then discounted back to present value,” he said.

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