According to John Petrovski, Managing Director | Head of United States Commercial Real Estate at BMO Harris Bank, the finance industry enjoyed—what he calls—mid-cycle acceleration. By that Petrovski means the market has moved beyond the downturn and is comfortably in the middle innings of the real estate cycle.
“First and foremost, at the property level, we’re seeing improved performance, increasing rents and occupancy,” Petrovski said. “Of course that’s not all the same uniformity across the country. There’s various places doing better than others, but generally things are doing better than over the last five years.”
“Property performance is also trending up,” he added. “So this mid-cycle acceleration has people trading and developing properties. It’s a nice time in the business. Prudent people may be looking over the horizon for risks or concerns. Right now there doesn’t seem to be a lot, but rising interest rates in the coming couple of years. So we’ll see what happens there.”
Petrovski said BMO’s expectation for 2015 is to match what they did last year—over $3 billion of financing in commercial real estate.
“Of that number, over $2 billion was what I call project finance,” he said. “There was modest growth over 2014, which was a strong year for us. We would look to do a similar number in 2015, perhaps a little more.”
With the market at a healthy state, the question is, is it getting easier for the developers and investors to acquire financing?
“In 2014 if you had a viable project it was easy to raise debt and equity for your project,” Petrovski said. “In 2015, the capital is equally easy, but what’s changed is there are a percentage of deals that don’t pencil as well as they did in 2014.”
Petrovski noted that at the start of 2014, virtually all proposed deals worked. “Looking at 2015, properties are more expensive, as well as land and construction costs. So by and large, the industry still works well, but margins have been pinched a bit.”
So what do developers and investors need to show lenders to improve their odds of getting financed? Petrovski noted that if you’re a proven developer, and you have a viable project, your odds of getting financed are very good.
“To get financed you have to show a viable project,” Petrovski said. “You have to show that you have the expertise to build it or develop it, and you have to show that you have an organization that’s appropriately skilled to tackle the project.”
“It’s usually harder for people just starting out to acquire financing because they don’t have the track record, expertise, the organization, or the financial strength and balance sheet.”
Petrovski said that BMO likes to see some financial strength in their developer clients so that if projects need more money, or if things move sideways for a slow period, they have the staying power to weather that time.
“So skin in the game also refers to them putting money in the deal,” noted Petrovski. “Generally, projects today all have equity in the deal, and the common structure would be the sponsor puts in some of the equity, gets investors for the majority of the equity, and the bank provides the debt.”
For those people who may not have done so well during the most recent economic downturn, according to Petrovski, they have to show that they have sufficiently recovered, and at least have a moderate amount of financial strength.
“Another thing for people that went through the downturn and had some struggles, they have to demonstrate how they have handled their problems during the downturn,” he said. “Did they work hard to recover money for their investors and protect their lenders? Were they win-win negotiators? Some guys really looked out for number one only, and they are difficult to lend money to.”
What property types in commercial real estate are getting the most financing deals today? Petrovski said that multifamily has been the hottest property type for the last three years.
“It’s because of urbanization,” he said. “People want to live closer to jobs and entertainment. They want to live in the city, and there are more rentals. I think there’s been a movement away from home ownership that’s been well publicized. So there’s a bigger demand for new, nice, big rentals or smaller—but less expensive—well located rentals.”
“Pre-leased office is doing well,” Petrovski noted. “Hotels are getting financing as well and certainly industrial with the amount of warehouses being built to accommodate the shipping of goods. Industrial has done really well, and the medical industry is growing by leaps and bounds in terms of medical office buildings, senior housing, etc.”
Petrovski said all of those sectors are strong, but what is less strong today is retail. “What you’re seeing is retail re-inventing itself. There’s still a lot of retail space. A lot of it still successful, but the ones that are poorly located are struggling, and online shipping and purchasing of goods is growing.”
For the large volume of CMBS loans with 10 year maturities coming in 2015, 2016, and 2017, Petrovski said the question is if the loans are going to provide a big demand for debt to refinance those.
“I’m a little bit less concerned about that because those lenders can extend those loans with a stroke of a pen,” he said. “I do think there will be a healthy amount of activity to refinance those loans. But I don’t think it’s any kind of issue for the industry.”
