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COVER STORY, FEBRUARY 2008
LENDING ACTIVITY
In 2008, cashflow and equity are in, growth rate assumptions are out.
compiled by Brian A. Lee
Amid signs that yields are not keeping pace and with companies hoping to find shelter from the housing fallout, investors and developers are seeing that financial leverage is a much harder thing to achieve nowadays.
In asking western lending experts to make sense of the challenging capital markets, Western Real Estate Business relearned an important lesson — it's all about fundamentals.
1) After 2007’s financial turbulence, what’s next for the commercial sector?
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Aden Kun is a vice president in Buchanan Street Partners’ Los Angeles office.
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Kun: 2008 will bring a return to fundamentals. Underwriting will be based on actual cash flow and not on lofty growth rate assumptions. The rising tide has receded but strong, experienced real estate operators will survive the financial turbulence. Having strong equity relationships will help navigate these choppy credit markets.
Tenzer: Changes in the macro economy and its effects on real estate fundamentals and net operating income growth will have a greater influence on the performance of the commercial real estate sector in 2008 then by changes in cap rates, which had such influence on the market last year. As a secondary factor, as we start 2008, the instability in the capital markets is continuing. While capital continues to be available, we are now in a lender’s market and borrowers have to think differently about their financing options and strategies.
2) What property type should stand out the most in 2008?
Kun: Industrial is still experiencing strong fundamentals, particularly in areas near ports and major cities. Multifamily demand should increase with the stringent underwriting for prime and jumbo loans and the implosion of the subprime residential lending business.
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Gary M. Tenzer is principal/senior director of George Smith Partners in Los Angeles.
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Tenzer: Since supply and demand for each asset class is determined on a local and regional basis, it is impossible to make a generalized predication of which property type will stand apart. However, if the country enters into a recession in 2008, virtually all sectors of the real estate markets will be affected.
3) What is the biggest concern or demand you’re hearing now from commercial developer and investor clients?
Kun: There is still a concern on the liquidity of the credit markets and how that impacts future acquisitions for a developer as well as concern from investors on how they can achieve their yield requirements with more expensive project level financing.
Tenzer: Investor and developer equity yields have been compressed by the reduced availability of financial leverage. To offset the drop in the return on equity, investors have to reduce the price offered to acquire property. However, owners are still reluctant to sell at the reduced prices. As a result, transaction volume has stalled while the expectations of buyers and sellers remain misaligned. The market will return to equilibrium when expectations change and/or capital becomes more available.
PACIFIC NORTHWEST: BRIGHT SPOT IN CURRENT LENDING LANDSCAPE
The often-rainy Pacific Northwest turns out to be a bright spot in the current national economy. With the “best bones” of anywhere in the country, Portland and Seattle were two of only three metro areas nationally to show year-over-year home price appreciation in the latest data from Standard & Poor’s/Case-Shiller home price index. The Northwest is well above the national average in home price appreciation, has a low inventory of unsold homes, and stands at roughly half the national average for rates of foreclosure. In-migration continues to support housing demand, population is up, quality of life is unmatched and the growth boundaries make metro areas positive pressure cookers. Employment, the Northwest’s weak spot historically, is holding. Even smaller markets such as Boise and Spokane have good job growth and limited overbuilding. While the bad paper works its way through and Wall Street stabilizes, in the Pacific Northwest, cash is king and cranes are in the air.
Boomtown to the North
In Seattle, a booming local economy has attracted more and more branch offices of national corporations — more than supply can support. New construction won’t be available for occupancy until 2009 and until then, lease rates will climb. Current $50 per square foot rates may reach $65 by late 2008, close to double year-ago rates. Local experts are calling 2008 “The Year of the Landlord.” Loan-to-value ratios will no doubt come down, but capital is still available for both stabilized and value-add deals.
Multifamily Hotter than Ever
Perception of a slowing condo market is a reality, and attention has shifted to multifamily development where favorable lending conditions and competitive underwriting make it the king of commercial product types for the moment. Though multifamily product as a whole still sees a net loss to condo conversions in the entire Pacific Northwest region during the past 5 years, the lagging pace of new construction helps to keep vacancy low and rents strong.
In Portland, skyrocketing rent growth in the past 10 months has not yet hit a ceiling. Seattle apartment vacancies are at their lowest level since 2000, and Portland’s were 3.3 percent in fourth quarter 2007. The tightening of finance availability for single-family homes puts a whole new subset of individuals and families in search of an apartment.
Hot topics for 2008 are mixed-use urban villages on one-time industrial sites, urban infill projects and live-work developments such as Milepost 5 in Portland and others like it in Seattle, Spokane and Boise.
Flight to Quality Borrowers
Without question, 2008 will see a tightening of underwriting standards for commercial real estate. Cap rates may edge up late in the year, but for now will stay in a compressed state. A best guess is that the conduit lenders will be hard to find during the first half of the year. As “on-book” portfolios begin to find favor, they will reappear. Until then, lending opportunities will be dominated by life insurance companies, who will pick and choose among valued offerings. Good projects with quality borrowers will find dollars to meet their financing needs.
Market specialist Jessica Wallenfels and the NBS Financial Services team contributed this report. |
Financing Factors: The Great Eight for 2008
1. Equity Required
2. Even More Equity Required
3. Return to Underwriting Fundamentals
4. Fewer Credible CMBS Lenders
5. Conservatism Dominates Portfolio Lenders
6. Continued Tight Credit Markets
7. Relationships Rule!
8. Best Mortgage Bankers Get the Best Deals
— Keith Russell is director of Las Vegas-based CommCap Advisors. |
©2008 France Publications, Inc. Duplication
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