Mariwyn Evans writes about commercial real estate for REALTOR® Magazine. You can reach her at email@example.com.
Financing Loosens Up
Lender confidence leads to more loans beyond gateway cities and Class A assets.
November 1, 2012
There are many reasons to feel positive about the state of commercial real estate finance. CRE loan originations for the second quarter of 2012 were up 25 percent over the same period in 2011, according to the Mortgage Bankers Association. And a growing number of lenders are looking beyond gateway cities and Class A assets when making loans, says Constantine Korologos, managing director with Deloitte Financial Advisory Services in New York.
Several factors are combining to boost lenders’ confidence. A stabilizing, if sluggish, economy and low mortgage rates, due to a capital flight from Europe, are raising the appeal of financing commercial real estate, says Jamie Woodwell, the MBA’s vice president of commercial real estate research. But improving property fundamentals and rising values in most property types are the key factors making the difference to lenders “all along the capital stack,” says Bill Hughes, managing director of Marcus & Millichap Capital Corp. Combined A and B loans can push loan-to-value ratios as high as 85 percent for the right property and an established sponsor, he adds.
REALTOR® Magazine’s examination of the state of financing for commercial real estate is brought to you by PNC Mortgage. An in-depth pre-approval process results in a more predictable outcome. The PNC pre-approval is underwritten by a PNC mortgage professional. We walk your client through the entire application process. We perform a full credit review and, if approved, the result is a true commitment to lend. From the start. See what makes us different at pncmortgage.com/agentalliance.
Another big consideration: the need for banks and life companies to get a decent return on their money. “The 15 life company lenders we work with are getting a better return from commercial real estate loans than from any alternative, at a risk they can manage,” says Tracy Knight, CCIM, a director with First Southern Mortgage Corp. in Nashville.
Where the Money Is
For the A+ property in major cities, life companies remain the lender of choice. After a strong 2011, life company loan volume grew another 10 percent year-over-year in the second quarter, according to the MBA survey. Competition from reviving CMBS is also making these lenders more aggressive, Knight says. “Many life companies are expanding lending to secondary markets. With Treasuries so low, borrowers can obtain very low interest rates (in the 4.25 percent range for 10 years) and still give the lender a pretty healthy spread.”
Commercial banks—national, regional, and community—have also stepped up lending by a whopping 58 percent over last year’s second quarter, according to the MBA. “Banks that have cleaned up failed loans are being much more aggressive and getting the message out that they want to lend. Loan officers are back to taking brokers to lunch,” says Ian Grusd, CCIM, SIOR, managing director with Sperry Van Ness Richter Grusd in Iselin, N.J. Another big boost for lending this year: Appraised values have risen and forecast values have improved, so loans are funded at higher levels, Grusd says.
Banks have benefited from a significant influx of deposits as investors look for safe harbors for their funds, says Shahid Abdulla, CCIM, vice president of commercial real estate lending with Broadway Bank in San Antonio. “Banks like ours with strong capital positions and good loan-to-deposit ratios are eager to lend to sponsors with significant equity,” he says. Most of his lending focuses on local borrowers with whom the bank has a relationship, although he is working with a few national developers.
Like other lenders, CMBS lenders are seeing an uptick in loan volumes—an increase of 16 percent from mid-2011 to mid-2012, according to the Mortgage Bankers Association. The CMBS sector has “a strong appetite for new originations that will probably send 2012 volume to near $40 billion,” says Woodwell. CMBS lenders are also extending their reach to secondary markets, says Hughes.
CMBS 3.0: Back, but No Boom
The climate for CMBS lending has improved significantly in the last two years. Even better: There’s improved consistency and transparency in the way that commercial real estate loans are being securitized, says Lisa Pendergast, managing director at Jefferies & Co. and a former president of the Commercial Real Estate Finance Council. “We’re largely going back to our roots and creating true conduits instead of fusions of pieces of many deals,” she says. In part, the change is occurring because lenders don’t want to hold loans on their books for the longer period it takes to create more complex combinations. The result is that conduit pools offer a greater diversity of property types, lessening investor risk.
Another key to making the new CMBS more competitive is creating more secure investments. “Issuers now are underwriting ‘A’ pieces of a security in excess of what is required by the rating agencies, so the bonds are less likely to be downgraded,” says Pendergast. “That’s more attractive to investors.”
What’s holding CMBS back from another boom? The concerns are largely over pending regulation. “Certain risk retention regulations would make it hard for CMBS lenders to generate sufficient return on capital,” Pendergast says. “If these regulations are put in place, there may be many fewer lenders in the CMBS world.”
New Sources Step Up
Despite big gains in financing activity, loan volume in 2012 remains only about half of what it was in 2007, according to the MBA. That has opened up niche opportunities for alternative lending sources.
“The newest kid on the block for commercial deals is credit unions,” says Todd Clarke, CCIM, president of NM Apartment Advisors in Albuquerque, N.M. Because credit unions are not under the same regulatory scrutiny as banks, they are often able to be more flexible in their lending. “They can often fund a transaction the same day,” says Charlie Foxworth, CCIM, SIOR, president of RE/MAX Commercial in Beaumont, Texas. And because credit unions know their borrowers, who must be members to secure a loan, defaults have been low and most balance sheets are healthy, says Fred Becker, president of the National Association of Federal Credit Unions.
The REALTORS® Federal Credit Union, a Division of Northwest Federal Credit Union, has increased its capabilities for making commercial real estate loans since its merger with Northwest in August. “We are actively seeking loans for owner-occupied commercial properties. This segment of the commercial real estate market has a lower risk profile and offers us the opportunity to build long-term relationships with operating companies that have a variety of banking needs,” says Jim Northington, RFCU’s chief credit officer.
Credit unions’ commercial lending rose 8.2 percent in 2011 but may decline this year as more credit unions reach the 12.25 percent lending cap, says Becker. The group is working to increase the cap, an initiative supported by NAR. Credit unions have also found creative ways to continue to lend. “I’ve seen several credit unions join together and finance a $7.5 million transaction,” says Foxworth.
Another lending group that’s finding opportunities to increase market share is mortgage REITs. “REITs aren’t tainted like private mortgage securities and aren’t encumbered with bad real estate loans like banks,” says Anthony Sanders, professor of real estate finance at George Mason University in Fairfax County, Va. Some mortgage REITs are positioning themselves to make longer-term loans that are too small to appeal to CMBS lenders, notes Korologos. “REITs are patient capital and fill a gap between hard money lenders and life companies,” he says.
REITs can raise capital in the public market and leverage funds, which lets them lend at a reasonable rate and still get a decent yield, Korologos says. The yield on the NAREIT Mortgage REIT Index was 13.7 percent in the second quarter of 2012, far outperforming equity REITs.
Uncertainty Could Undercut Gains
Although there’s plenty to feel good about, lender optimism is diminished by uncertainty over future employment, economic growth, and European debt. And because only about 30 percent of the regulations for the Dodd-Frank Act have been completed, the regulatory environment is also creating tremendous uncertainty among lenders, says Sanders.
The recovery itself may be sowing some seeds of future trouble, says K.C. Conway, executive managing director of market analytics at Colliers International. Conway is concerned that many institutional lenders are so eager for current yields that they aren’t considering how these loans will be refinanced in a few years. “When you see structures like a 1.3 debt coverage ratio on an interest-only loan at a 3.5 percent interest rate, in a secondary market, you have to wonder who is going to take that out,” he says.
Another concern is what will happen if the GSEs pull back from multifamily lending. Freddie Mac and Fannie Mae saw their loan volumes grow 50 percent in the second quarter of 2012 over the preceding year. The good news is that reforming the GSEs “will make Dodd-Frank look easy,” says Conway, so it’s likely to take years before allocations change.
Still, as 2013 nears, most commercial analysts and practitioners expect next year to look much like 2012. “There are those properties that will struggle, but in the main, the lending market is looking positive,” Hughes says.