The financial markets are much calmed since last summer's CMBS debacle and lenders have once again become aggressive in their pursuit of deals.

"We're very bullish on the market. We're increasing our staff," confirms Craig Johnson, a director in the CMBS program in the Irvine, Calif. office of Phoenix-based FINOVA Capital.

Rob Carter, a partner in Charlotte, N.C.-based Berkeley Capital Advisors, agrees there is a lot of capital looking for places to settle. He says his clients have generally been successful in landing loans - as he puts it, "No one has come up empty" - but their success has come at a price.

Last spring's spreads of 120 to 180 basis points over 10-year Treasury bills are gone, with most lenders today quoting in the 240-point range. Compared to last fall's quotes of 270 basis points and more, however, 240 looks good. Even better, most lending professionals report spreads are continuing to drop.

In fact, some sources already are reporting deals with spreads of 200 to 220 points. Carter says a new center with solid supermarket and drug anchors can find loans at a 220 spread. Robert Caine, a principal with Plaza Realty Advisors in San Francisco, the exclusive representative for Prudential Insurance Co.'s PruExpress loans in Northern California, reports quotes of 185 points over Treasury for a Safeway-RiteAid anchored center in Davis, Calif., but he acknowledges a very special situation. A vehement environmentalist ethic has kept the relatively affluent university town extremely understored by today's standards, with very few national retailers.

Caine's colleague Tom McKnew, also a Plaza Realty principal, recently completed a $10.5 million deal in San Jose at 170 points over Treasuries. What made the deal so attractive was the quality of the anchor, Home Depot, which will occupy all but 7,500 sq. ft. of the 112,500 sq. ft. center, and the project's location in a drastically land-short market that is experiencing rapid income and population growth.

According to Craig Mueller, a director in the Newport Beach office of Dallas-based Holliday Fenoglio Fowler, institutional-quality anchored neighborhood and community centers can get spreads in the 190-200 point range. He pegs spreads in the 225-240 point range for conduit quality product and the 240-270 point range for unanchored centers.

There is a hitch to the improving scenario, unfortunately. As spreads are dropping, underlying Treasury rates are rising, leaving borrowers in a not especially improved situation. Consequently, the number of deals being made remains relatively low overall.

"We've seen a lot of folks on the fence," says Caine. "I'm not sure investors and borrowers are comfortable with today's rates." He estimates the rate averaged about 7.5% in early April. Others give a 7.5% to 8.5% range. Compared to rates throughout most of the past two decades, 7.5% looks like a bargain, but compared to figures quoted a year ago, it looks less attractive.

Borrowers, says Caine, have been standing back to see if levels might drop again as quickly as they rose. He believes they will start making deals again as it becomes clear levels will not drop to last year's lows.

Two factors lie behind the drop in spreads. First, lenders have come to recognize the economy in general and retail economy in particular have considerable underlying strength. Second, the excess capital that caused the CMBS debacle did not lead to significant overbuilding, as some analysts feared it would, leaving demand and supply in basic balance.

The crisis, in fact, appears to represent the market's effort to correct itself before significant problems had a chance to develop. The hope when real estate and real estate loans began trading on Wall Street was that securitization would prevent the kind of bust that occurred in the late-'80s, where lenders continued to fund new projects even though the market did not need them. Apparently it worked - developers were reined in before they could go overboard with new construction.

Financial conduits were not so lucky. Many of them fell by the wayside. For example, in the 1998 ranking of top retail lenders by NREI's sister publication, Shopping Center World, Nomura Capital held the number two position, behind Lehman Brothers, with nearly $3 billion in loans. The Nomura division was doing so well that in May it split off into a subsidiary called Capital America and moved from Nomura's New York headquarters to expensive digs in San Francisco.

Within six months, Capital America was on the ropes and in January Nomura pulled the plug, dissolving the company, abandoning the new offices and moving the division back to New York. Since then the division has remained largely inactive, its energies focused on cleaning up the mess rather than making new deals.

Last fall's turnaround caught many people by surprise. Michael Surber, president and CEO of USA Funding, Inc. in Carmel, Ind., says his firm was working on a $150 million deal when the crisis hit. "The lender was offering an 85% LTV one week. One week later it was 75%," he recounts. As a result, the deal stalled for three months.

Ray Garland, first vice president and managing director of the San Jose, Calif., office of CB Richard Ellis, reports he participated in a December acquisition that had fallen apart twice in the preceding months because the attempted purchasers, both national REITs, had been unable to secure viable financing. The property, the 94,289 sq. ft., Safeway-anchored Snell Branham Plaza in San Jose, ultimately sold to San Diego-based Burnham Pacific Partners, which has an exclusive relationship with the California Public Employees' Retirement System that has given it access to nearly $1 billion in funding for retail investment.

The abruptness of the CMBS crisis understandably gave investors the willies. Despite assurances of the market's fundamental soundness, people wonder whether more unwelcome surprises might lie around the bend. The political and economic turmoil in other parts of the world certainly don't help matters.

For the moment, however, the retail market appears solid and investors are gradually returning. Almost everyone contacted for this article reports increasing activity, as both borrowers and lenders loosen up. Nonetheless at least one major obstacle stands in the way of substantial improvement: the shortage of product. Observers give several reasons for this.

First, with construction down, the number of newly completed projects is minimal. And thanks to the lack of construction, owners are reluctant to sell. As Garland explains, with little new competition on the horizon, properties should be able to hold their value for a fairly long period. In the meantime, sales are strong and returns are growing. "You have current owners who are enjoying the fruits of ownership and can wait until buyers become more aggressive," he says.

In addition, most of the better existing properties have sold in the past two years and values have not risen enough to make subsequent sales worthwhile. "Much of what remains on the market are Class-B or -C centers, and they'll have difficulty selling," says Richard W. Latella, a senior director in Cushman & Wakefield's Retail Industry Group in New York.

Analysts expect the holding pattern to break fully by summer, and lenders report they are gearing up for a busy year. According to Latella, construction is getting back on track, with a healthy volume of fresh starts, particularly in Florida and California. Some observers caution that supply is starting to outpace demand in the Dallas, Phoenix and Atlanta CBDs.

Greg J. Spevok, director of originations for Bear, Stearns in New York, says his firm is "aggressively seeking good deals," while Geoff Arrobio, a vice president in the Los Angeles office of Irvine, Calif.-based Johnson Capital Group, Inc., declares, "We're hungry to do deals. We're actively marketing."

Johnson exclusively represents both Prudential Insurance Co. and Prudential Capital Co. in Utah, Arizona, southern Nevada, southern California and Hawaii, and Arrobio says the statement applies to both entities. He reports his firm handled about $250 million in retail loans for the two companies from mid-'97 to the end of 1998.

A good indicator of the improved financing picture is that many lenders' goals for '99 exceed '98 levels. Joseph Cunningham, president of Liberty Mortgage Acceptance Corp. in Sacramento, Calif., reports Liberty did about $150 million in retail loans last year. He expects to do $250 million this year.

Matt Lituchy, a senior vice president for Cleveland-based Key Bank and director of the bank's Northern California office, says Key Bank has set a goal of $1.6 billion in retail lending for the year, compared to $100 million from September '97 to December '98.

Mueller reports Holliday Fenoglio also anticipates a higher level of activity this year than last. He mentions the firm completed $3.28 billion of property loan transactions last year, a significant portion of it retail.

"[Our office] did $8 million last year, compared to $10 million in '97. That included fixed-rate, joint ventures and dispositions. Debt, equity and dispositions are our chief line of business," he says.

Judging by first-quarter activity, his office appears to be on target to exceed last year's figure. By April, Mueller remarks, he already had 2 million sq. ft. of retail property in the market for loans.

He notes HFF has some "interesting pockets" of permanent money available for not-yet-built supermarket-anchored centers in California. Making the money especially attractive, he adds, the lender is willing to lock in the rate at the start of construction so the developer need not worry about rates changing by the time construction ends. "It's pension fund money. Therefore the investor's willing to take less of a return," he explains.

Even the conduit market is coming back. According to Latella, analysts project 1999 will see $60 billion to $65 billion in CMBS transactions. "That's off from last year but still substantial," he notes.

Today's conduits, however, are more likely to be divisions of banks, insurance companies and other well established firms than the new generation of financial companies that sprang up in recent years. "These are not cowboy lenders like some of the conduits have been," says Arrobio. "We've all been here for many years and plan to be around for many more."

As evidence of the trend, Lituchy reports Key, which has traditionally done only construction lending, did about $600 million in permanent loans through the CMBS market last year. Prudential Capital itself is a prime example of a conduit arm of a traditional lending source. Arrobio says about 40% of his office's retail loans come from Prudential's capital side.

Typical of conduits, Prudential Capital has looser requirements than Prudential Insurance. The latter requires a supermarket anchor, a high percentage of credit tenants and borrower credit. The maximum LTV is 75% and minimum debt coverage is 1.2. Rates are in the low 7% range, with 10-15 year terms on 25-year amortizations. Thirty-year amortizations are possible for newer centers.

Other lenders report similar criteria, terms and rates, though there are variations. For example, ORIX, a New York-based direct lender, rarely offers terms longer than five years, according to Matthew Judge, an assistant vice president for the firm. But unlike Prudential, ORIX will do construction loans, even if the borrower does not have a permanent lender in hand.

Prudential Capital, on the other hand, will do unanchored strips and offer LTVs up to 80% for anchored centers, with debt coverage of 1.25. The maximum LTV for unanchored centers is 75%. There are costs for the greater liberality, however. Rates are several basis points higher and take-out loans are not available. A minimum 12-month history is mandatory.

According to Spevok, the amount of money available through conduits actually has changed very little. It's only the number of conduits that has changed. He terms the remaining conduits extremely strong. As he puts it, "They have been through a cycle that was as bad as anyone had ever seen...and proven themselves well able to handle rough seas."

One thing that appears not to be changing is LTVs. Though some respondents report 80% LTVs for the very best deals, all agree the standard is 75%. Deals at 85%, they say, are unheard of.

One of the upshots of the lower LTVs, points out Surber, is that developers have greater need for equity funding. Many borrowers that can come up with 15-20% of project cost cannot manage five to 10% more without additional help, he says.

Unfortunately, equity funding seems to be hard to come by. "It's low on the priority list right now. [Capital sources] want regular loans first, because it's their bread and butter," says Jeff Johnson, executive vice president of Midland Loan Services in Kansas City, Mo.

It is not exactly that equity is in short supply. In fact, according to Gary Mozer, a senior vice president with George Smith & Partners in Los Angeles, funds are more than ample. Not much of it is being given out, however. And of that being distributed, there are few enough sources that they feel free to pick and choose the best prospects with no need for sweetheart deals. Many observers expect the number of sources to rise as confidence returns to the market.

The keys to success right now, Mozer emphasizes, are high return and low risk. "If you have a to-be-built supermarket anchored center that is 80% preleased, people will throw money at you. The same goes for a regional mall with committed anchors and 60% preleasing on shop space," he says.

According to Mozer, the rule of thumb is 200 basis points between the stable cap rate, which is defined as the stable net operating income divided by project cost, and the exit cap rate. That is, if you start with an 11 cap rate, you need to be able to sell at 9.

Among the sources respondents give for equity are hedge funds, investment banks, credit companies, pension funds, some banks, "high-net worthers" and some REITs. Surber reports his firm has 600 to 700 funding and joint venture partnering sources in its database, though a borrower has to be open to creative solutions to make a deal work. Lawrence Bond, managing director of the Summit Fund in Los Angeles, says his firm is actively looking for retail opportunities, as well as new relationships.

Because of the suddenness of last year's turnaround, most respondents hesitate to express certainty about continued upward movement. Nonetheless, they say almost all signs point to steady improvement. Lenders have become more adverse to risk, but in general industry professionals see this as a strength rather than a weakness. This conservatism, they say, will save the market from another crisis.

"If you really look at what happened in October, I think the core players went back to what they know," says FINOVA's Johnson. "We don't have to stretch to do the weaker assets." That does not mean, he adds, that only the strongest assets will get financing, but rather that weaker assets will have to wait until lenders begin to build volume again.

As Johnson sums up the situation, it is a matter of optimistic caution: "We look at everything as if the market could fall apart tomorrow. We don't think it will, and it doesn't stop us from lending, but it means we want good, solid properties."