Jeanne Peck, associate director at Berkadia, finds it interesting how new programs in commercial real estate finance reflect the current state of the industry.
Like the fact that there being more equity out there than ever before has become a real “vote of confidence” for real estate as an asset class.
These days, multifamily and industrial are lender favorites, according to John Parrett, first vice president of debt and structured finance at CBRE’s Capital Markets group. He said both value add and stabilized office are also highly sought after, while grocer-anchored and well-located retail assets always get a good financing execution.
Peck said the broad market health and increasing rents of multifamily have attracted capital like no other asset class. She said industrial is right there, too—almost all of the capital sources Berkadia works with seek to add to their industrial portfolios.
Today, allocations are steadily increasing in real estate mortgage production levels for life insurance companies. Peck said Freddie Mac and Fannie Mae have both shown a commitment to providing liquidity in the market as well as for improvement in their processes to reduce approval, rate lock and closing timelines.
Two lending types have also experienced increased activity in 2015 CRE finance, according to Parrett.
The late third and fourth quarter in 2015 have been volatile times in the commercial real estate debt markets. While many transactions are still being done, Parrett said hiccups in the global capital markets and the uncertainty of the Fed’s next rate move has caused volatility.
Recently, commercial real estate loan spreads—generally linked to corporate bond spreads—reached their widest point since mid-2012. This, he said, created a ripple effect through the pricing desks of life companies, agencies and securitized lenders.
“Depending on lender type, all-in lending spreads have widened 20 to 60 basis points since mid-August,” he explained.
And what’s not helping is that many life company lenders reached their year-end production goals by Labor Day, which stopped their urgency to aggressively pursue new business.
But Parrett noted that throughout the first two quarters and even early third quarter of 2015, a generally favorable interest rate and spread environment dominated.
Being able to produce a significant volume of commercial mortgages helped them keep on pace with record-breaking loans (sub-4 percent for 10-year loans).
Although CMBS production in early 2015 outpaced 2014 production, it has gone down in the fourth quarter. However, Parrett remains optimistic, saying that CMBS will likely end the year slightly above 2014’s production levels.
“2016 should bring refreshed enthusiasm to the debt markets,” he said.
Real estate fundamentals are steadily improving and Parrett said most life company lenders have 2016 allocations that are equal to or greater than their allocations in 2015.
“CMBS and debt fund lenders are also showing a healthy appetite for deals,” he added.
And with CBRE investment sale professionals reporting robust transaction pipelines heading into the new year, overall transaction volumes are expected to grow.
According to Parrett, debt funds and other bridge lenders have been a dominant player in the market place.
“I would argue that the bridge lending market is the most competitive portion of the debt capital markets today,” he said. “This is primarily due to the exceptional liquidity being provided by a wide variety of different ‘types’ of lenders.”
Active bridge lenders can be: debt funds, investment managers, domestic and international banks, family offices, Wall Street firms and life companies.
In recent years, pricing and deal structures have become more borrower-friendly as liquidity and competition in the market has grown, while real estate and economic fundamentals have steadily improved.
Lender spreads are approximately 100 basis points lower than they were 18 months ago, according to Parrett. Optimal pricing is being met on larger deals above $75 million, where aggressive pricing on both the A and B notes can be obtained. A lot of this is done behind closed doors, he said, as most lenders tout the ability to close on the full loan amount and syndicate post-closing.
It doesn’t seem that the bridge lending market will be slowing down anytime soon, despite it becoming increasingly difficult for borrowers to find high quality value add deals.
“CBRE has seen continued downward pressure on loan spreads while lenders have simultaneously become more aggressive on structure,” Parrett said. “Nearly every bridge lender CBRE has spoken to in recent months has indicated that their 2016 allocations and production-targets are at or above 2015 levels.”
The biggest challenge Peck sees today is managing expectations in the tumultuous CMBS market. Spreads have widened and exceeded the expectations of most experts, and Berkadia has seen deal terms change without material reason due to the increased influence from “B-piece” buyers on credit decisions.
“We must strive to manage borrower expectations on securitized deals like never before,” Peck said.
Parrett has seen that lenders are maintaining discipline. Not only are they underwriting with income in place and calculating debt yields and debt service coverages based on that underwriting, but they are also structuring and collecting reserves for higher LTV loans.
“With all this discipline, the greatest challenge is maintaining the balance between an aggressive, attractive loan structure,” he added. “Significant equity is being infused into transactions, compared to when roughly 80 percent LTV was commonplace on a standard first mortgage between 2005 and 2007.”
Commercial mortgage LTV’s generally top out at 75 percent LTV for CMBS loans, Parrett said, and approximately 65 percent for LTV for life company loans. Multifamily mortgages are the only ones that regularly top out at 80 percent LTV with Fannie Mae and Freddie Mac.
How do developers qualify?
To start, developers need to have a well-planned and highly feasible project. Peck said they also must be able to show a strong balance sheet and track record to convince construction lenders and equity partners to invest in their projects.
“We are seeing that financing is available to both vertically integrated developers doing the development, construction, engineering and architecture all in-house, as well as those outsourcing that expertise to strong outside third-party companies,” Peck explained.
Some developers have been able to negotiate the equity partners take on some of the repayment guaranty to satisfy lender requirements.
“It continues to take time and careful though when putting development deals together,” she added.
Has it become more difficult over the years? Peck said it has.
She explained that while finding the right debt or equity for a CRE project has never been easy, the current market is more inefficient than in years passed so it continues to be a difficult process despite the increased capital sources.
“Vetting the capital sources and deals beforehand remains a vital part of any successful financing,” Peck added.
Parrett mentioned that a good site, with “market” pro forma rents and a healthy yield-on-cost will generate good appetite from lenders.
And while multifamily projects lead the vast majority of construction loans, well-located commercial projects with pre-leasing are also highly demanded.
Basel III in general is making it harder to obtain non-recourse construction loans at higher leverage and is also creating requirements for more equity in transactions.
Parrett explained that a solution to this requirement is that many construction mezzanine lenders are structuring their investments as preferred equity so that the capital structure meets a bank’s requirement.
And as higher leverage non-recourse construction financing from banks is becoming more difficult to obtain, Parrett said there have been many non-bank construction lenders that entered the market in the second half of 2015.
“These lenders offer higher leverage, non-recourse construction financing, albeit at higher yields,” he explained.
Several construction lenders have expressed a desire to see how some of their existing projects work out before making additional loans and this has become a general sentiment among some lenders.
Peck says to keep an eye out for more volatility in the next few months as the Federal Reserve manages the strengthening economy, and federal regulations impacting the banking and CMBS industry come into play in the upcoming year.
Meanwhile, Parrett stated that despite some volatility in the market, it’s a great time to be a borrower. He said there is a significant amount of capital chasing a limited amount of deals, which creates competition among lenders and results in attractive loan terms for borrowers.
“It is an outlier market and if a deal fits a lender’s target parameters, they will make an aggressive loan,” he explained. “The key is marketing each financing opportunity to match up with that ideal lender and structure.”