FEATURE ARTICLE, SEPTEMBER 2009

NORTHEAST FINANCIAL Q&A

Northeast Real Estate Business asked experts from each area of the  commercial real estate industry to give their insight on the status of the financial market and its effects now and down the road.

NREB: How would you characterize the current lending activity in your area?

David M. Rosenberg is managing partner of Deerwood Real Estate Capital.

Rosenberg: The lending environment in the Tri-State area is still moving along. While banks have certainly pulled back some and tightened up their underwriting criteria, deals are still happening with a lot of the local and regional banks. Multifamily is still strong, and many commercial deals are still financeable. There may end up being some structure to a deal that may not have been there a couple years ago, or in some cases some recourse, but deals are still happening. In addition, the foreign lenders and life companies are still playing selectively on larger and lower leverage deals.

NREB: Are we starting to see some recovery?

Rosenberg: I don’t know if I’d call it a recovery yet, but it appears that some lenders want to do deals more that they did a little while ago and many owners are “looking” for deals and opportunities. The big issue is that the people that are sitting with cash on the sidelines are looking for blood in the streets, and we have not seen those trades/liquidations happen yet.

NREB: What can we expect to see down the road in 3 months, 6 months, a year?  How will lending change? 

Rosenberg: I think at some point things will loosen up a bit. I’m not sure of the exact timeframe, but hopefully within the next 12 to 24 months. Good deals can get done. Whether through straight debt, or recapitalizing the equity, good deals can get done. I think the conduit will come back in some form, but clearly much different than what we’ve seen in recent years.

NREB: How would you characterize the current lending activity in your area?

John D. Lyons is chief executive officer and president of Savills US.

Lyons: Underwriting remains very conservative for both acquisition and construction financing. Not only are lenders demanding more up-front equity from borrowers, but the securitized debt market (CMBS) has not fully recovered. This is an important point because until recently the CMBS market was a vital source of financing for the commercial real estate market.

Life insurance companies also are finding it hard to lend money in this market for two main reasons: Number one, there are few new acquisitions and secondly, investors do not want to borrow 60 percent loan-to-value (LTV) in order to refinance higher balanced loans. Conversely, the regional and local banks are doing deals, but it’s important to note that these are smaller deals that typically fall below $10 million.

As such, lending volume for CRE has been sparse as there are very few transactions or refinancings taking place. Servicers are unwilling to foreclose on properties in this market and as a result they are working with owners to amend and extend the loans.

NREB: What are the biggest factors affecting the real estate financing industry? How so?

Lyons: The single biggest factor is the government and whether its new programs aimed at CRE debt will effectively resuscitate the market. TALF, which stands for Term Asset-Backed Securities Loan Facility, is one example. Even though the program was announced in the spring, we still do not have a sense of what securities are ‘TALF-able’, making it difficult for private investors to move forward on deals. If there were increased certainty regarding TALF, this would likely spur added interest from these quarters.

Another factor impacting the CRE financing industry is that servicers are extending loans and working with borrowers. In addition, LIBOR floaters on many properties are saddled with 100 percent-plus LTVs, and the debt coverage is still positive. This cannot last for two reasons: Either the loan itself will mature or LIBOR will increase at some point.

NREB: How have the dynamics of a deal changed?

Lyons: Not too long ago, Interest Only (IO) loans were part of a typical underwriting. So was non-recourse debt. Today, fixed-rate loans are the norm. And recourse debt also is quite common. It’s very hard to describe how the specific dynamics of a deal have changed simply because there have been very few deals.

Based on the few deals which have taken place, the average percentage of so-called ‘floor rates’ [meaning the lowest interest rate any lender is now willing to offer] is 7.25 percent. It’s doubtful that any deals will get completed at a lower interest rate than that.

And lenders now dictate the terms, unlike the most recent boom in which the borrowers were courted by the lenders. Borrowers face a much different underwriting climate today.

While the majority of new capital has been raised to fund so-called ‘distressed’ deals, very little of this capital has entered the market. This suggests that the fund managers and operators sense that we have not yet reached the bottom of the cycle (meaning the opportune moment to invest). When we begin to see more of this capital flowing into the market — and I strongly believe that will be soon — the recovery will truly take hold.

NREB: How would you characterize the current lending activity in your area?

Dr. Peter Kozel is senior managing director for FirstService Williams.

Kozel: Based on our experience and the aggregate numbers on commercial real estate lending, it is fair to say that, at best, in recent months the new loans issued are just replacing what is rolling off. Of course, for residential properties or development activity the level of loans outstanding is down dramatically.

With the weakness in the economy, the demand for space has contracted, meaning that it is difficult to justify new construction. The slippage in the level of outstanding loans may therefore be the result of both tighter credit conditions as well as weaker demand.

NREB: What are the biggest factors affecting the real estate financing industry? How so?

Kozel: At the peak in activity, close to one-half of the new mortgages issued were securitized, and that market has simply closed down. Many of the traditional buyers of securitized assets have curtailed purchases or left the business. For the financial institutions that were balance sheet investors, capital adequacy issues along with a changing regulatory environment have both curtailed their absorption of mortgage debt.

If the banks have several more quarters of good earnings growth, they will slowly begin to increase the amount of commercial real estate related paper that they hold. Properties that bring the debt along with them are clearly in a stronger position.

NREB: How have the dynamics of a deal changed?

Kozel: With so few deals done in the past year, it is difficult to determine what the appropriate market price range is for a specific property. Of course, the sellers have a different price range in mind than do the buyers. This apparent disconnect is not just the result of obstinacy on their respective parts.

The seller my have heavy debt service obligations that make it difficult to accomplish a steep price reduction. The buyer at the same time has to accommodate much more expensive debt and a smaller relative amount of debt available for the transaction. These limit how much the buyer can afford the offer for the property.

Given the massive changes in market values and the reduced amount of debt capital available, much effort is needed in confronting these realities so that deals can get done.

©2009 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.