Commercial real estate markets on either coast are outperforming assets in the mid-U.S. because they are home to gateway cities that trade with Asia and Europe. The hottest of these markets right now is the New York metropolitan area, as it’s experiencing an 8-year low in the supply of residential real estate; but other national markets may provide better risk adjusted returns, according to Matt Galligan, president of CIT Real Estate Finance at CIT Group Inc., a provider of financing and advisory services to small businesses and middle market companies. Galligan further discusses the opportunities and challenges in the sector, the role of private equity firms in the industry and trends to watch in the “2013 Commercial Real Estate Sector Outlook,” the latest in a series of in-depth executive Q&As featured in CIT’s Executive Insights series.

Multifamily Market – Opportunities and Potential Challenges

According to Galligan, there are plenty of opportunities across all markets, however, there’s some concern with the Class A new multifamily market. “If interest rates increase, or as residential mortgage lending thaws, providing home loans to first-time buyers, it could put pressure on that asset class where capitalization rates are incredibly low,” he said. “There are also opportunities with Class B multifamily assets in the Midwest, where the capitalization rates are higher and demand is quite strong. Additionally, convenience oriented strip shopping centers in the Midwest tend to hold their value because the threat of a new supply is not great.”

Private Equity Firms Now Major Players

In sharp contrast to institutional ownership in previous years, where insurance companies and pension funds had become the largest acquirers of real estate in the U.S., private equity firms are now buying real estate investment trusts (REITs) and repositioning them into private companies. “A great example is the Blackstone Group’s recent purchase of Duke Realty’s suburban office holdings,” said Galligan. “As a result, Blackstone has become a major player in suburban office space in the Midwest and suburban Atlanta markets.”

Distressed Commercial Properties Offer Opportunities

There’s an abundance of new projects to repurpose financially distressed commercial buildings, as well as recapitalizations. “During the Great Recession there were many ventures in the urban core of cities that had significant investment in them, but were stopped mid-stream,” said Galligan. “These projects often were acquired below replacement cost from the original developer and provide very good lending opportunities if the new business plan is sound.”

Constrained European Banking Market Presents Opportunities

As the European banking market remains constrained, many European banks continue to retrench. “We are witnessing a change regarding who will provide capital,” said Galligan. “The European banks don’t have equity right now to support even modest losses, so replacement capital will come from U.S. banks that have strong capital ratios and high liquidity.”