Commercial lending volume for direct lenders and financial intermediaries soared to new heights in 2004, but industry veterans caution that the prospect of higher long-term interest rates, which already has some lenders dialing back on originations, will make a repeat of last year's performance difficult, if not impossible.

“The market is getting frothy,” says John Case, executive vice president and national sales manager at KeyBank Real Estate Capital. “There's just too many folks trying to chase too few deals, so we're concerned where the market is headed in the next 12 to 24 months.”

Originations mushroom

According to the Mortgage Bankers Association (MBA), commercial and multifamily loan originations rose to $136 billion in 2004, up 16% from 2003's record $117 billion. “That volume shows a very competitive capital market,” says Jamie Woodwell, senior director of commercial and multifamily research at the MBA.

Similarly, NREI's 2005 Top Lender Survey reflects soaring lending volumes. Bank of America, which ranks No. 1 for the second straight year, nearly doubled its volume of direct lending year-over-year. In 2004, Bank of America financed $58.6 billion of commercial real estate loans, up from $29.6 billion in 2003.

Eugene J. Godbold, Bank of America's president of commercial real estate, says the bank's clients boosted volume by increasing their activity in both refinancing and acquisitions. “There was a confluence of everything coming together at the same time: a pick-up in the economy, historically low interest rates and massive amounts of capital in the real estate sector,” Godbold says.

In the case of Wachovia, this year's No. 2 lender, a November merger with SouthTrust Corp. helped the bank more than double its volume to $46.8 billion, a 123% increase from the $21 billion recorded in 2003. That enabled Wachovia to move up one notch, from No. 3 to No. 2. Managing Director Bill Green says an increase in construction activity in the Southeast helped boost volume.

KeyBank climbed two spots to No. 3 on NREI's 2005 Top Lender Survey, cranking out $18.8 billion in loans compared with a 2003 volume of $11.8 billion. KeyBank's 66% growth in volume reflects a beefed-up institutional practice and the work of new offices in Charlotte, Houston, Atlanta and several Florida cities.

Among intermediaries, Bank of America topped NREI's ranking with $49.7 billion in arranged loans, up slightly from 2003's $44.4 billion. Holliday Fenoglio Fowler (HFF) remained in the No. 2 spot with $22.3 billion, a 38% increase from the previous year's $16.2 billion. L.J. Melody & Co. retained third place while boosting volume from $11 billion in 2003 to $13.2 billion.

“Clearly, real estate has achieved a valid asset class status over the last two or three years,” says John Pelusi Jr., executive managing director at HFF.

Tapping the brakes

This year started on a course to break records again. Gross Domestic Product (GDP) growth in the first and second quarters could outpace the 3.9% growth of the second half of 2004, according to the MBA's March economic commentary. Additionally, the 10-year Treasury yield as of mid-April registered 4.3%, quite low by historical standards.

Another plus: Occupancy rates around the country are ticking upward with improving real estate fundamentals, adding a “comfort factor” that properties stand to increase their revenue streams and values, says MBA researcher Woodwell.

Still, there is good reason to believe that the large annual increases in lending volume in recent years can't continue. The MBA projects the 10-year Treasury yield to reach 4.9% by the end of 2005 and a 5.2% rate in 2006. Higher rates mean more debt service, which will likely dampen borrowers' enthusiasm.

KeyBank is already curbing lending and expects its volume in 2005 to fall short of the $18.8 billion notched in 2004. The company is focusing on loans with existing customers, emphasizes Case, and only approving construction loans for projects that will later qualify for permanent financing, even in the event that interest rates climb several percentage points.

The bank assumes rates will be considerably higher in a couple of years, and it is relying on pension funds or other institutions to buy out its loans at that time.

“We are starting to tap the brakes,” Case says. “We want to win new business, but at the same time we want to be smart about a rising rate environment and how that is going to impact the borrower and the lender's exit strategy.”