Interesting Times

Don't Expect a Gush, But Lenders Are Lifting Capital Constraints

Numerous indications over the past few weeks point to an easing of investment capital for real estate deals. Life insurers have become more active lenders; new CMBS offerings are hitting the street; syndicators are starting to assemble new CDO offerings; and bank loan officers are reporting the first easing of lending standards in years.

The ongoing recovery of the capital markets is being aided by an improving U.S. economic recovery. Employment appears to have entered a period of consistently stronger growth, manufacturing output is expanding robustly, and business confidence is up. Corporate profits continue to be a core source of strength for the U.S. economy and corporations are spending more on new technology and new hires, which should reinforce employment growth and bolster consumer confidence.

"From nearly every capital segment there are more active participants and the competitiveness among lenders has intensified markedly over the last few quarters," said Tom Fish, of Jones Lang LaSalle. "The CMBS market has re-emerged and is once again considered a viable component of the market."

Though commercial real estate lending is still down 75% from peak levels, it has rebounded in the past 12 months. It was up 88% in the first quarter of 2011 from the first quarter of 2010.

Leading the charge have been life insurers. Their balance sheets are much further along the recovery path than their counterparts in the banking sector, and issuance since the third quarter of 2010 is running at about 90% of average 2005-2007 issuance in this sector, according to Mark Fitzgerald, a debt strategist for CoStar Group.

However, its composition has changed dramatically over the past two years, Fitzgerald said. Refinance activity averaged 12.8% of total lending volume from 2000 to 2008, but jumped to a little less than 30% in 2010. In addition, risk tolerance remains very low, particularly for new business.

Life insurers are focusing the vast majority of their new lending on large deals. While this has been a longer-term development since the early 1990s (as expected with increases in asset values over this period), this trend has ramped up significantly since 2008, despite sharp declines in CRE values. In 2010, just less than 75% of all new lending volume was on loans greater than $25 million.

The focus on larger assets in core markets has helped to fuel the divergence between pricing on large loans and that of the rest of the market, Fitzgerald said.

Meanwhile, many lenders are still dealing directly with the aftermath of the downturn. Legacy assets continue to restrict new lending availability, he said. For many of those with capital to deploy, the pain of the credit crisis remains front and center. However, history has shown that the most attractive lender returns are earned on the bottom-of-the-cycle vintage loans, Fitzgerald added, which is contributing to the greater availability of funding.

Brian Staffers, president of CBRE Capital Markets, reported this week that loans that were virtually impossible to fund at the beginning of 2011, now command multiple lender bids. Loan-to-values are higher, debt yields are lower, interest only is coming back and even some special purpose assets and non-credit single tenant properties are receiving substantive lender attention.

"These are all the logical results of a more-competitive environment," Staffers said, adding however, "this does not represent exuberance. We see lenders making rational decisions based on valid inputs and thoughtful consideration."

Banks Easing CRE Lending Standards

Banks are slowly ramping up their commercial real estate lending, according to the Federal Reserve's quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices. In the recently released April survey, 5.5% of respondents said their banks eased standards for CRE loans in the prior three months, the first such loosening of bank credit since the fourth quarter of 2005.

Nearly 35% reported stronger demand for CRE loans from creditworthy borrowers, the largest quarterly jump in 13 years.

BB&T Corp., a major regional bank based in Winston-Salem, NC, is just one example. It has doubled the portfolio lending capacity of its BB&T Real Estate Funding group from $400 million to $800 million.

"We expect 2011 will be a very strong year for us," said Kirk Booher, manager of BB&T Real Estate, which sources all loans through Grandbridge Real Estate Capital. "We are seeing increased transaction activity and improved fundamentals in the marketplace, particularly for multifamily, our preferred property type."

That isn't to imply that all banks are out of the woods yet. For starters, the banks that indicated an increase in demand were almost all large domestic banks, noted Robert Bach, senior vice president, chief economist for Grubb & Ellis. Other domestic and foreign banks reported little change in demand for CRE loans on net, he said in a report this week.

The outstanding volume of bank CRE loans, at levels last seen in late 2006, continues to fall as the increase in REO properties outpaced the issuance of new loans, Bach noted in analyzing the Federal Reserve loan officer survey.

Overall, capital availability is increasing for commercial real estate across most sources of debt and equity, Bach noted. Although prices have moved higher for core assets in primary, supply-constrained markets, pricing for slightly riskier assets (older, more vacant space, secondary location, etc.) remains low, tempting investors and lenders with visions of buying low now and selling high down the road when the market fully recovers.