During a period of slack demand for new product, a growing and competitive base of capital exists for anyone who has a shopping center to build.

The pipeline for construction financing probably has not been this generous for a decade as a host of new lenders from insurance companies to Wall Street investment firms compete with local banks for the attention of developers. One inadvertent result of the heightened competition has been compression of the yield curve, which would even make borrowing cheaper -- if there were retail projects in need of loans.

"Yields on construction financing probably dropped 120 to 150 basis points over the last two years as competition got stronger for financing," reports Patrick McDonough, senior vice president and manager of construction financing for Seafirst Bank, Seattle.

As the July 21 Commercial Real Estate Quarterly, published by Nomura Securities International Inc., reports: "the so called expansion phase of the real estate cycle [in retail property markets] witnessed a flood of capital chasing deals. This tends to flatten pricing."

A year ago, yields on construction financing might have resided in the 200 to 225 basis points over LIBOR range. Now, financing is probably around 150 basis points over LIBOR.

Nomura Securities is one of the new lenders entering the retail construction financing fray. The company transacted what it calls a "fair amount" of construction financing during the past four years, mostly involved with the repositioning and rehabilitation of existing shopping centers. In January, Nomura turned up its business a notch, going after new development.

Stewart Ward, a managing director and head of construction lending at Nomura, says his company has a strong shot at about $400 million in construction financing to the retail sector. However, "given the competitive world out there, my expected pipeline to date is in the $150 million range," he estimates.

BankBoston and Fleet Bank are two Boston-based financial institutions taking different tacks with regard to construction financing. In 1996, BankBoston did about $200 million in construction loans to retail, but into August 1997, the company transacted only $75 million and does not expect to hit the $200 million mark this year. Focusing solely on the New England market, Floyd Wiggins, a division executive at BankBoston, observes, "new construction has been fairly sparse."

Fleet Bank, perhaps noting the scarcity of new retail construction in its home region, opted for a national focus and created in January 1996 the Shopping Center Lending Group dedicated to financing retail development.

"We thought it was an industry focused enough and cohesive enough, so that if we had specialty products geared to shopping center finance, we could respond aggressively and carve out a larger portion of the business," says Ron Lubin, a senior vice president and team leader of the new group. In this first full year in operation as a lender, the Shopping Center Lending Group probably will do about $750 million in construction financing.

"There's no question there has been an increase in the number of banks doing construction lending," says Michael Buchanan, executive vice president of Charlotte, N.C.-based NationsBanc Capital Markets, an advisor to NationsBank. "Any bank that is going to be involved in real estate construction lending is back."

Even specialty originators are doing well. NationsBank helps fund and is now in an alliance with Capital Lease Funding L.P., a New York-based specialist in net lease loans. Construction loans through Capital Lease Funding run $1.5 million to $50 million with interest at LIBOR plus 1.5 percent to 2 percent.

U.S. Bancorp, the bulked-up entity resulting from the merger of U.S. Bancorp of Portland and First Bank System of Minneapolis, estimates this year it will do $750 million in construction lending -- about the same as it did the prior year. One of the reasons for the lack of growth, says Joe Hoesley, a senior vice president, is the competitiveness of the industry. "There's a lot of liquidity in the marketplace with a proliferation of lenders that weren't around three or four years ago," he says.

On the other hand, U.S. Bancorp maintained 1996 lending levels because of what Hoesley calls "relationship" lending. "We follow our borrowers wherever they go. We go all over the United States with them," he notes.

L.J. Melody, the Houston-based mortgage banking company acquired by CB Commercial in 1996, has been an aggressive lender doing about $3 billion in mortgage originations. The company also has been doing take-outs on original construction financing. Now the company is poised to do construction financing, hoping to do its first loans this year.

"As the construction market improves and as more funds are available, we will be looking at those types of opportunities," says Brian Stoffers, executive vice president for L.J. Melody.

Additionally, L.J. Melody has a union pension fund through its institutional real estate advisory company, Westmark Realty Advisors, which also is interested in placing construction and take-out combinations. "This would wrap things up in one package, one fee and one set of loan documents to convert to a permanent loan," Stoffers adds.

The retail market could easily handle the competitiveness among construction lenders if there were a strong demand for new space. While demand in individual markets may be strong, the national picture is still bleak.

After observing that rents in the retail sector are improving for the first time in years, Jim Costello, a research economist at CB Commercial Torto Wheaton Research, says it was caused by "less construction." The forecast for retail rents is reasonably positive because of a forecasted reduction in new completions of shopping centers.

"In order for a recovery to happen, construction must be limited to under 3 percent of stock per year nationwide," he says. "Pessimism in some circles about the retail market may allow this to happen."

The increase in total square footage of retail space nationally ran 3.5 percent last year after being under the 3 percent mark for the past three years. Costello expects the percentage increase for 1997 will be about the same as the year before. Broken out by sector, the total square footage for neighborhood retail centers rose a weak 1.07 percent in 1996, community retail centers 2.65 percent and regional retail centers 5.74 percent.

Meanwhile, the 1997 Investment Strategy Annual, produced by Chicago-based LaSalle Advisors, reports a weakness in key retail property sectors, in particular big-box retail and power centers. According to LaSalle, power center construction, while proliferating in growth areas, is starting to slow down as retailers look for profit over market share. "The future performance of power centers is subject to a fair amount of uncertainty and risk because of the difficulty in forecasting retailer consolidation and store closures," the report reads.

"The only product that has really turned down is the big box," confirms Buchanan of NationsBanc Capital Markets. "We are doing about the same amount or maybe a little more [lending for] the food-anchor led -- maybe with drugstore -- centers. These things are popping up all over urban locations."

At GMAC Commercial Mortgage, the focus is on neighborhood centers almost exclusively. "I've been concerned about changes going on in the market," says Vacys Garbonkus, a senior vice president and head of construction lending for GMAC Commercial Mortgage in Chicago. "There's an oversaturation of outlet malls and consolidation in power centers. We've been mostly lending to developers of supermarket-anchored, community shopping centers."

The past few years witnessed a resurgence of downtown retail. Projects from the much publicized Times Square in Manhattan to projects in cities as disparate as Newark and Phoenix are bringing in long departed entities such as supermarkets and cinemas.

McDonough says downtown developments keep the Northwest market afloat. "More dollars will go into the downtown type of project rather than power centers in outlying areas," he says. "Downtown Seattle is probably at a peak in terms of new development. Bellevue, Wash., also has some projects proposed that we will probably finance."

The one drawback to downtown redevelopment has been the cost, which is even more expensive on a per square foot basis than building a regional mall. Downtown projects, however, may become more attractive as lenders compete in a slowing development climate.

Downtown redevelopment usually does not require a lot of ground-up construction as existing buildings are rehabilitated into larger retail properties. However, whether new construction takes place in a downtown or at an existing suburban mall, the risk factors considered by lenders are similar.

In any construction lending deal, primary risks always include completing construction on time and within budget, explains Wiggins of BankBoston. With new construction, he continues, the market dynamics, lease rates as compared to construction, and the market's reception toward certain tenants also factor into the risk/ reward equation.

"In a rehab project, you have already crossed the hurdle as to how the project will perform," he says.

"In new construction, no matter how well you study the market, you are still 'crystal balling,'" Wiggins explains. "You don't have a market that has been tested and tried. You are hoping the developer, you and the retailer all have done the homework as to how sales will be so as to justify the rent."

Construction lenders appear to have done their homework with regard to the economy. As they vie for loans, they do so in a market where supply is meeting demand and where rents are increasing. Like a rookie center in the NBA, the retail market has been pummeled in recent years, but as CB Commercial's Costello says, "now it's ready to rebound."

Steve Bergsman is a Phoenix-based freelance writer.

The results of an informal survey by Greystone Realty Corp., Stamford, Conn., indicate that lenders are moving aggressively into construction financing. According to Greystone, participants represented 12 of the nation's "top commercial lenders."

Responses to the survey indicate that: * Eighty percent of respondents are lending for development, compared to only 50 percent three years ago. * Lenders will fund an average of 85 percent of a project's development costs or 75 percent of the projected stabilized value. * Ninety percent of lenders making construction loans will do so with no permanent take out in place; 80 percent will make the permanent loan themselves.

"We've been impressed with the aggressiveness of the institutional capital sources in development lending lately," says Donald Conover, chairman for Greystone. "There has been terrific competition between lenders to make new loans on stabilized commercial real estate, but development lending hadn't really taken off until recently."

Lenders participating in the survey report they are interested in lending for the construction of suburban office buildings, neighborhood shopping centers and garden apartments. Only about one-third of these lenders will consider construction lending for central business district office buildings.

"The commercial lenders are finding they've got to compete with the Wall Street lenders, who are aggressively lending at better rates and with higher loan-to-value ratios to bring new mortgage product into the securitization pipeline," says Charles Lauckhardt, chief investment officer for Greystone. "Development lending is clearly part of their strategy."

Lauckhardt reports that, for new construction, Wall Street firms are generally lending 5 percent more of construction costs than commercial banks, and they are lending 5 percent to 10 percent more of stabilized value. Unlike commercial banks, however, many Wall Street lenders will not make a construction loan unless they get the permanent take out for securitization, he notes.