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COVER STORY, JUNE 2011

MID-YEAR LENDING UPDATE
Nellie Day

Western Real Estate Business recently talked with some of the region’s largest lending players to get an update on how the market has changed, what borrowers should expect now and where the industry may be headed.

How would you describe the current state of the commercial lending market?

The market is very strong right now. The mortgage industry on the commercial side is certainly coming back. My opinion of the mortgage industry is that we have weathered the storm. Some velocity has come back into the marketplace, partially driven by low interest rates, and partially driven by the increasing liquidity that our lenders have. Mezzanine players are starting to come back as well.

- Michael Kaplan, COO and principal, Barry S. Slatt Mortgage Co.

In general, I think the market is good. It’s healthy. It’s obviously much better than it’s been in the past few years. There is still some bifurcation, and there’s still the story of the haves and the have-nots in terms of core products and institutional-owned product that is very well leased. Stable product has a ton of debt and equity chasing it.

- Marcia Diaz, managing director, Prudential Mortgage Capital Co.

What are banks focusing on right now?

Owner-user real estate loans are in high demand by banks because they do not fall into the same category as investor loans. For most banks, concentration in real estate loans remains an issue. However, well-capitalized lenders willing to take balance sheet risks are very active with investor real estate loans that have conservative structures with regard to leverage and debt coverage.

- John Houten, executive vice president, Sunwest Bank

Banks are focusing on where to place safe, high-quality loan assets right now. Their top priority is to deploy their deposit liabilities into loan assets, but in safe places, even if the yields are extraordinarily low. The collateral supporting these loans are usually fully stabilized, in core markets, and with conservative underwriting and loan structures, all in exchange for attractive current rates.

- Dan Borland, president of income property banking, Opus Bank

Which Western markets are doing particularly well?

In the major metro markets like San Francisco, Los Angeles, San Diego and Seattle, when attractive, appropriately-priced buildings are offered, they are receiving multiple offers.

- Al Brooks, head of multifamily and commercial mortgage lending, Chase Bank

Western markets that are performing well now include the coastal metropolitan markets in California.

Namely, San Diego, Los Angeles and the San Francisco Bay Area. These markets seem to be well positioned with constrained supply, population growth, and job growth, which is boosting demand and creating positive leasing absorption and rental growth outlook.             - Borland

Which Western markets are still struggling?

Flagstaff and some of the in-between markets in Arizona continue to decline. Also, the Inland Empire  has yet to correct.            - Houten

Markets that are still stagnating include Orange County, the Inland Empire, Central Valley, Sacramento, Las Vegas, Phoenix and Portland metro. These markets had a heavy oversupply of housing and commercial real estate, and they are not yet being positively impacted by job growth.             -Borland

Are there certain market segments that just haven’t weathered the financial storm quite as well as others?

More challenging properties in secondary markets,  B or C class assets and properties that aren’t leased are definitely having much more trouble finding capital. The CMBS market has come in and is starting to help in some of those secondary markets again, but it’s nowhere near where it needs to be to get us to where we were in the past few years.             -Diaz

The middle-market investor class. There are few lenders serving the middle-market investor class today. There are a substantial number of these small and mid-size investors who survived the past financial downturn intact, only to now find few lenders willing to lend in this space. These investors are active and have financeable balance sheets, but have limited capital options to finance their growth. This is causing prolonged economic stagnation.            -Borland

How does today’s lending environment differ from the one that emerged after the early 1990s’ recession?

The biggest difference this time is that the market in the major Western metro areas was not swamped by excess inventories. In markets like Florida, where there were a huge number of foreclosures on condos that, in turn, became shadow rental units, the declines in value were much more severe. If you look at peak-to-trough pricing of assets, this last downturn has not been as severe as the recession of ‘91 and ‘92.            - Brooks

This lending industry has been very difficult for those with high leverage. The emphasis on global cash flow is the heaviest I have seen in more than 25 years. For the newly created funds or those clients who have kept leverage to a minimum, the opportunities are getting better as lenders need earnings from organic lending. -Houten

Do you think fear has finally subsided?

There is still some fear out there because a number of loans today will be maturing in the next 2 to 5 years. A tremendous amount of clients are inquiring about what they should do. Do they pay their prepayment and refinance for 10 years, hoping that’s enough to get them through the cycle? Or do they borrow longer? We’re advising many clients who don’t have highly levered properties to borrow long term, 10-plus years. The fear isn’t so much on the market losing steam, the fear is, 3 to 4 years out, what are we going to be faced with as far as interest rates go? If interest rates are at 8 percent to 10 percent, that will impact cap rates and the overall value of everyone’s property. Then we may see another fallout down the road. - Kaplan

I believe that fear has subsided both in the equity and debt markets. However, that does not mean that fear has given way to reality. The financial markets have changed. The emphasis is on knowing your borrower, your customer, your lender, etc., and being able to verify and validate repayment ability. If you look at leverage as being a part of an overall business plan and not a business plan in itself,  knowing the cash flows and value of the levered asset help mitigate the fear of default. The real fear is that some people are not qualified to own or operate real estate, and a market such as the one we are in now will weed those owners out.             -Houten

What is keeping you busy in this marketplace?

We’re focusing on core products. We’re really looking for institutional-quality assets with very strong borrowers. They need to be strong financially and have a lot of experience in the market and in the asset class. We’re really trying to make loans on properties with very low volatility in primary markets. There should be low risk, not a lot of lease ups, near terms or lease rollovers. And obviously we want solid underwriting and stable cash flow. That is what we’re concentrating on.            - Diaz

Our focus is on continued growth and facilitating the relationships we have. Our lenders and life insurance companies have increased their allocations for commercial financing every year for the past 3 years. There is probably a 30 percent increase from last year in terms of money allocated for commercial properties. Our lenders are asking us to go out and find good, quality deals that are conservatively underwritten. So that’s what we’re ready to go and do. We’re looking for transactions that are well located with good sponsorships behind them. - Kaplan


©2011 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.






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