Low interest rates combined with a lack of attractive investment alternatives have driven commercial and multifamily lending volume to record levels. But concerns about softening underwriting standards and an overheated condo conversion market — particularly in South Florida — are pestering even the rosiest outlooks for the industry going forward.

“Commercial real estate has exceeded expectations over the last several years, and we've all used words like ‘frothy’ and ‘bubble,’” says Eugene Godbold, president of commercial real estate banking at Bank of America. “But obviously capital's not going to exit our space until there's a better alternative, or until we do something that doesn't meet the expectations of capital.”

Bank of America retained the top spot in NREI's 2005 Top Lender Survey. The banking giant financed $58.6 billion of commercial real estate in 2004, nearly double its volume in 2003. It also remained atop the list of intermediaries, arranging $49.7 billion in 2004, a 12% increase over its originations in 2003.

Climbing the ranks

Certainly investors remain enamored with real estate. Commercial and multifamily mortgage bankers originated $31.4 billion in loans during the first quarter of 2005, an increase of nearly 40% over the first quarter of 2004, according to the Mortgage Bankers Association. That performance has set a torrid pace for 2005 that is unlike any the MBA has ever seen, reports Doug Duncan, MBA's chief economist and senior vice president.

KeyBank Real Estate Capital climbed to No. 3 from No. 5 in the direct lender category. Year-over-year, its financing volume ballooned 60% in 2004 to $18.8 billion. E.J. Burke, executive vice president and director of commercial mortgage at KeyBank, credits the bank's expansion in the Southeast and Houston, among other initiatives, for the boost in volume. In mid-June, BioMed Realty Trust tapped KeyBank for $600 million in three separate credit facilities and used the financing to acquire a 1.1 million sq. ft. property portfolio in Massachusetts and New Hampshire from Lyme Properties and Lyme Timber Co.

But Burke suggests that the flood of capital searching for real estate deals is creating unhealthy competition between lenders who are structuring loans with weaker standards and lower risk-adjusted returns. “We won't see the effects for a couple of years,” he says. The good news, he adds, is that improving real estate fundamentals may offset the riskier bets.

Wachovia also recorded a banner year, financing $46.8 billion of commercial real estate in 2004, up from $21 billion a year earlier, enabling it to climb one notch to No. 2 in this year's survey.

Much of the activity stemmed from refinancing as owners sought long-term, fixed interest rates as short-term rates rose, says Brett Smith, the head of mortgage origination for Wachovia's Real Estate Capital Markets Group.

Smith expects more of the same this year. The 90-day London Interbank Offered Rate (LIBOR) climbed to about 2.7% at the beginning of 2005 from less than 1.1% in early 2004. As of mid-June, 90-day LIBOR had risen to 3.4%. On the other hand, the 10-year Treasury yield, the benchmark for long-term, fixed-rate real estate debt, has generally ranged from a still appealing 4% to 4.5% over the last nine months.

Condo Crazy

Holliday Fenoglio Fowler retained its No. 2 ranking among intermediaries, arranging some $22.4 billion in 2004, compared with $16.2 billion in 2003, while L.J. Melody & Co. remained the No. 3 intermediary, seeing volume climb to $13.2 billion in 2004 from $11 billion in 2003. Holliday recently arranged for $152.3 million in acquisition and mezzanine financing for a condo conversion in Miramar, Fla. But John Pelusi Jr., executive managing director for Holliday, echoes the sentiments of a lot of real estate experts who wonder if the bottom will fall out of the condo conversion market.

Indeed, in mid-June, Fitch Ratings released a special report that predicted 10% of condo conversion loans originated in 2005 would default. Why? Among other worries, Fitch believes that a growing number of speculative buyers are creating artificial demand for the product and that rental streams from apartments that fail to convert would not cover the property's debt coverage.

“There are probably some legitimate concerns about the condo conversion market being completely overheated,” says Wachovia's Smith. “In some markets the activity is probably sustainable; in others it just seems to be a craze.”

Despite the creeping anxiety over condo conversions and underwriting standards, most financing experts are bullish on the next six to 12 months: Fundamentals continue to improve, developers have generally kept new construction in check, and interest rates should remain attractive for the foreseeable future.

“Barring any unforeseen event,” Pelusi says, “we don't see an abatement of the money coming into real estate, even if the industry were to turn down a little bit.”