from Essex Financial Group in Denver
Commercial & Multi-Family Financing Commentary – February 2010
The 2010 Mortgage Bankers Association conference in early February was very encouraging compared to a year ago. Following are the key “take-aways” for commercial real estate investors:
LIFE COMPANY NON-RECOURSE FINANCING
* The “relative value” of yields on alternative fixed income investments such as investment grade corporate bonds has significantly declined over the past 6 months. This has resulted in pent up demand for mortgage investments by virtually all life insurance companies. Spreads narrowed by 50-100 basis points in the past 90 days.
* Accounting rules were changed by the ACLI (American Counsel of Life Insurers) at the beginning of the year to a simplified debt coverage test. The changes to “MEAF” (Mortgage Experience Adjustment Factor) accounting rules have generally improved life company balance sheets providing increased lending capacity.
* Although Life companies generally view commercial mortgages as better investments in terms of risk / yield compared to a year ago, they’re still being conservative on their underwriting. This is expected to change as early as 1Q10 mainly due to a scarcity of deals that fit their investment criteria. Most of the life companies acknowledged they’ll likely need to offer one or more of the following to win business:
* Reduce rates
* Offer higher proceeds of 70-75% LTV
* Reduce heavy-handed loan structuring such as tenant improvement and leasing commission impounds to mitigate lease expiration risk during the loan term.
* The amount of mortgage capital life companies are targeting to invest in 2010 is approximately 2-3 times higher than 2008 and 2009 combined.
* The majority of REITs refinanced in the first half of last year. The low hanging fruit in terms of high quality properties at low LTVs has been picked.
* The gap between the cap rate lenders are underwriting compared to the appraised value / market cap rate has narrowed around 50 basis points on average. Some deals are going under contract at the same cap rates life companies are underwriting internally.
RECOURSE BANK FINANCING
* Banks will continue to scrutinize the borrower’s entire real estate portfolio via a “global cash flow” analysis. This will result in a scarcity of deals for banks and more competition.
* Proceeds and rates for 5 year terms are now about the same (+/-6%) with both life companies and banks.
* Banks are anticipated to win business by providing higher proceeds vs. a lower rate.
* The majority of banks that financed any developments during the past 3 years will continue to have balance sheet lending constraints as loans mature with no ability to be taken out by alternative financing.
MULTI-FAMILY FINANCING
* The theme is “get it while the gettin’s good” due to the uncertainty on what the government administration will decide to do with these programs in the future.
* No major changes on underwriting – 80% LTV is still achievable in most areas in the metro Denver area.
* FHA lending sources had record years in 2009. Thy benefited from many borrowers’ inability to get enough proceeds from FNMA or Freddie because of higher vacancy and lower income trends. In addition, HUD was the only viable source for multi-family construction loans last year.
PREFERRED EQUITY / MEZZ FINANCING
* New sources have emerged with money priced for the gap between a 60-65% life company loan and the 75-80% loan typically needed (if not more) to take out existing loans.
* Preferred equity providers will have very good opportunities to invest in 2010 as loans mature and/or borrowers run out of leasing capital.
* Most lenders with a senior loan position won’t allow a mezz loan unless the mezz lender has an established track record as a good real estate operator.
* Preferred equity sources are targeting preferred returns ranging from 8-10% and an IRR in the low to mid teens. These return requirements are 200-300 basis points lower compared to last year.
BRIDGE LENDERS
* Bridge lenders raised new funds and have increased lending capacity.
* Targeted returns range from 14-18%. Required returns are down 300-400 basis points compared to a year ago.
* Although bridge lenders will structure loans similarly compared to life companies, most anticipate getting market share by offering structured loans on properties that don’t fit life company lending criteria. Good examples are properties that are more than 25% vacant or have major tenant lease expiration risk.
CONDUITS
* The money center banks are back in the market this year. They plan to hold loans on their books until they can accumulate a pool of several hundred million and test the market appetite via a securitization on a multi-borrower loan pool.
* Although there were only a few securitizations last year, the loan pools were with single borrowers on quality, stabilized properties at 50% LTV.
* Conduits will attempt to win deals by offering higher proceeds. They aren’t anticipated to be competitive on rate until they complete a few securitizations.
* Most want loans over $10MM or more on quality properties in quality locations. They’re anticipated to reduce their minimum loan amounts contingent on the success of the next securitization.
* Conduit spreads are approximately 75 basis points higher than life companies.
* The majority of conduit loans are anticipated to be refinances as most sellers won’t consider a buyer’s offer that’s contingent on closing a conduit loan.
On the equity side, investors are frustrated with the lack of deals on the market. Some investors that raised capital over the past 24 months are at risk of losing funds that were committed to be invested and/or they’re getting a negative arbitrage on the money. This has resulted in the same mindset that life company lenders have. Investors must lower return expectations and / or consider properties that don’t fit the majority of their investment criteria. In addition, many private syndicators and pension fund advisors can’t survive without transaction fee income because asset management fees aren’t enough to keep the lights on.
In summary, pent up demand on both the debt and equity side should result in a significant improvement in transaction activity on refinances, loan restructurings and acquisition financing in 2010. This year may be a great window of opportunity for some borrowers to take advantage of an unusual imbalance between supply and demand for quality commercial mortgage investments.
Ed Boxer
Essex Financial Group, LLC
303-796-9006