Although the big continue getting bigger, there are smaller niche markets being left behind, creating opportunity for more focused and individual lenders.

Capital liquidity exists for every type of real estate investment risk today," opines Hugh Zwieg of CMD Realty Investors Inc. That, he adds, is both a benefit and burden.

The good new is, borrowers have a variable access strategy either through sale or recapitalization, and they can run the spectrum of how to position investment structure and risk, explains the executive vice president of the Chicago-based real estate company. The bad news is, there is more competition than ever on the lending side.

Last year, the total amount of equity flowing from capital sources reached $320.6 billion, while total debt climbed to $1.1 trillion, reports ERE Yarmouth Investment Research. No declines in either debt or equity capital flows should occur in 1998, which means there won't be any shortage of funding sources. As in past years, Wall Street is expected to be at the forefront of capital raising activities through real estate investment trust and commercial mortgage backed securities related transactions, reports Emerging Trends in Real Estate 1998, a publication of ERE Yarmouth and Real Estate Research Corp. Other active players include life companies, banks and foreign investors.

As proof of what it calls a "capital surge," Emerging Trends noted equity flows in 1997 were up by more than 15% over 1996 while mortgage loans increased 7% - the biggest percentage increase in more than 10 years.

While REITs continue to dominate the headlines, especially as they have become the largest owners of real estate, the mortgage side of the business is undergoing some fundamental changes as well. Private lenders such as banks and insurance companies still dominate shares of total debt outstanding, but the trend line does not bode well. The lending growth of banks is flat, while that of life companies is slipping, says Emerging Trends. In contrast, total CMBS issues have multiplied in capitalization 22 times since 1990 to reach $143 million last year and now command 13% marketshare of the debt universe.

Last year, CMBS securitization reached $44.3 billion, a record that will easily be eclipsed in 1998. First quarter volume shows $20 billion in securitization, and estimates for the year run anywhere from $70 billion to $80 billion.

The ceiling could be a long way off. The commercial mortgage market is about $1.2 trillion, and today only about 11% of that market is securitized compared to the single-family industry where 60% to 80% is securitized.

"Larger and larger assets are being securitized and higher and higher run the quality of assets, and that is fundamentally being driven by the acceptance of the bonds by bond buyers," says Kurt Wright, executive vice president with ERE Yarmouth and CEO with its new REIT Chastain Capital. "More and more people have moved into CMBS. It is highly liquid, and the spreads have moved down, and that has made it easier to securitize higher quality assets."

"It is going to keep getting bigger," avers Hal Holliday, president of the Commercial Mortgage Banking Group at AMRESCO Inc. "The story in real estate continues to be the transformation of private debt and equity market capitalization to public market capitalization."

Today, AMRESCO can boast its own market capitalization of $1.5 billion. The Dallas-based company has grown relatively quickly through internal expansion and key acquisitions, including Holliday Fenoglio in 1994 and Fowler, Goedecke, Ellis & O'Connor last year. In CMBS, AMRESCO is a solid player with $34 billion in servicing and $9.5 billion in originations last year. This year, AMRESCO expects to do $12 billion in originations.

Mega-merger mania "We used to consider AMRESCO a battleship out on the seas," Holliday jests. "Today, we feel like a toy boat." The difference in perception goes to some very recent developments in the financial services world, the mega-merger. Every one of the recent announced deals - Citicorp and Travelers Group, Bank of America and NationsBank, and BancOne and First Chicago - was involved in CMBS and securitization, Holliday says. In addition, AMRESCO often deals with these companies. Citicorp, for example, was AMRESCO's partner on its April securitization.

"They are such big organizations, they can have a huge impact on the market while in effect taking very little risk. They can aggressively put loans on the book and not even worry if the market goes bad," says Holliday.

Draper & Kramer, a full-service real estate company in Chicago, has been enjoying a very busy 1998. Among other services, the company brokers deals to various conduits. In 1997, Draper & Kramer did about $250 million of debt placement. This year, it will do $300 million, working with companies such as AMRESCO. Draper & Kramer has also done deals with First Union, Chase Manhattan, Lehman Brothers and Nomura.

"This year all of these companies will stay around, but two years from now, mergers will change the conduit business and some of the smaller companies will fall away," says Bill Barry, a senior vice president at Draper & Kramer. "There will be continued consolidation among insurance companies, banks and mortgage banking firms. We haven't seen the effect yet, but eventually all this will affect our company as there will be less and less sources available, less and less competition."

First Union Corp. has been one of the most aggressive acquirers of financial service companies in recent years. In 1997, First Union grabbed Richmond, Va.-based Signet Banking Corp., Wheat First Butcher Singer Inc., a brokerage company also with headquarters in Richmond, and the large Philadelphia banking firm, CoreStates Financial Corp. This year it bought The Money Store Inc. The aggregation of all the new companies transformed First Union into a financial services powerhouse with $208 billion in assets - the 18th-largest mutual fund provider, the second-largest home equity lender and 12th-largest mortgage servicing company. With NationsBank, the other Charlotte, N.C., banking company merging with Bank of America, most suspect First Union will look for another merger very soon.

First Union is also a major CMBS player. According to Commercial Mortgage Alert, the CMBS industry newsletter, First Union last year was the fourth largest conduit securitizer and the largest commercial bank securitizer with a volume of $1.6 billion. Last year, the company did two large securitizations for $1 billion and $2.2 billion with Lehman Brothers, and it is putting the finishing touches on a $3 billion securitization that it will do as a joint venture with Lehman Brothers and Bank of America.

"The marriage between securities firms and banks is something First Union recognized the value of a long time ago, which is why the company's capital markets group was started," says Barry Reiner a managing director and head of First Union's Commercial Real Estate Finance Group. "The marriage of investment banking (Citicorp and Travelers Group) is a good idea and will help the market better meet the needs of customers."

Will the current round of mega-mergers affect Reiner's operation? He says, no. "Frankly, I look at it more from a marketshare perspective. We are very focused on marketshare where we had about 7% of the market in 1997. The fact that two companies that may each have 2% of the market get together doesn't really have any impact on us."

Even before its planned marriage to NationsBank, Bank of America had already laid out an aggressive strategy in regards to CMBS. Christine Garvey, group executive vice president of BofA Commercial Real Estate Services, says her company will go from zero to $1 billion in pool sales this year. As to the proposed merger, Garvey likes the fit. "We are in most of the major areas of the country, although the Northeast is not covered by either one of us. The combination will create a very strong conduit business. In the next three years, we will be one of the top five conduit generators in the business.

The timing is ripe, she adds, because profitability is going to be narrower than Wall Street likes, so conduits will become more like a banking business. "The volume will make a lot of sense for us in terms of profitability," she adds.

Banks follow insurers in consolidation It doesn't seem so long ago that there were 30 to 40 life insurance companies and numerous savings and loans lending money to real estate. Today, the S&Ls are mostly gone and about five or six life insurers still lend to the market. Now going through the consolidation process, banks are headed in the same direction as the insurers, observes James Howard, a managing director and chief financial officer at TransAtlantic Capital Co. LLC in New York. "The remaining companies are larger, which means the barriers to entry are higher. Financial companies now need to be large enough to warehouse and incubate product while at the same time have the expertise in origination. Other companies may now become discouraged at the barriers and leave real estate lending."

Lehman Brothers' Michael Mazzei would agree: "It can go either way. There will be guys who decide they want to be given an enormous capital basis and want to grow, and there will be some who will want to go away. Bank of America and NationsBank both have conduits, and they may decide to make it bigger. First Union, Wells Fargo and Chase Manhattan are huge players in the conduit market. These banks haven't consolidated yet so we have to wait to see what will happen."

Whether a bank like Chase Manhattan merges with another bank or not, it won't change the direction of the business, says Peter Baccile, a managing director and Chase Manhattan's new head of Global Real Estate. "Financial institutions are going to end up being niche players or top global players. If you want to be a top-tier player, you are going to have to offer the full product spectrum. Consolidation will give institutions much broader capabilities and give clients a break - they won't have to deal with 26 bankers knocking on their door," he adds.

What is happening in banking is the same thing that happened in other industries, says Ron Dipasquale, head of the Structured Finance Group Trading Desk at Nomura Securities International. "The normal outcome of capitalism is monopoly and before you get there you go to oligarchy. The Citibank and Travelers merger is a normal outcome."

But is it beneficial to the industry? "When you look at the volume needed to be profitable and who is going to be the lowest cost producer, on a comparative basis, the bigger ones are going to do it better," says Dipasquale.

It also won't hurt to take a few players out of the game, says Baccile, "since the sector is overbanked to begin with."

When the already big get even bigger, they do leave behind smaller market niches, or at least that is the theory proposed by Michael Goldsmith, group president of Heller Financial Real Estate in Chicago. "There is a wonderful position being created that will be focused on servicing particular markets and niches where service and personal touch account from something," he continues. "Big organizations don't necessarily respond very quickly to individual needs in the marketplace. In addition, a $5 million investment for Heller is meaningful and important. A Citigroup would have a hard time focusing on businesses that don't hit their 'scale.' A lot won't hit the radar of an $800 billion institution."

Mortgage banking faces change Mortgage bankers long held a key role in underwriting loans, offering local market expertise to lenders and providing an ongoing liaison between borrower and lender. That role will greatly be altered, predicts Future Shocks 1998, a Prudential Securities research publication.

Greg Spevok, director of national marketing for the commercial debt finance group of Bear Stearns in New York, takes a much more optimistic view of the mortgage banking business. "We have every reason to believe that side of the business will remain extremely strong. Securitized lending hasn't hurt them. Mortgage bankers are not going to go away. We believe they will be around and remain strong."

Bear Stearns doesn't do business directly with owners but only through mortgage bankers, and it has a number of formal agreements with mortgage bankers around the country.

Spevok is not as sanguine about commercial banks in regards to the CMBS business. Recently, he reported two "significant" banks approached Bear Stearns about converting their business into brokerage shops to feed loans to it. "Those are the kinds of conversations we weren't having six months ago," says Spevok. "As portfolio lenders, they just cannot compete with securitized product. For them to be actively shopping for Wall Street partners is extraordinary as they have been Wall Street's competition. These are the companies that have done this business in huge scale over the last couple of decades."

Commercial banks, he adds, can originate enough volume, but it is another thing to distribute and, except for a few banks that have the capabilities to securitize volume, "they need major bond houses."

Debt financing sees more players On the debt side of real estate finance, there are a wide variety of players in the market, even some in the form of REITs. Take a company like Dynex Commercial, a wholly owned subsidiary of Dynex Capital, a Glen Allen, Va.-based debt REIT traded on the New York Stock Exchange. Dynex doesn't buy property, it lends money. Traditionally a multifamily lender, the company moved into commercial lending last year. Of the $400 million it did last year, $150 million was commercial. This year, Dynex expects to do $600 million worth of business, of which $150 million will be commercial.

Despite those good numbers, Peter Van Graafeiland, an executive vice president at Dynex Commercial, maintains it is a brutal market these days. "Everyone is being squeezed, including the mortgage banker and broker. Mortgage bankers are under a lot of pressure on fees, rates and spreads. Five basis points can make or break a deal sometimes. The market is that competitive."

ERE Yarmouth had until recently joint ventured a conduit with Donaldson, Lufkin & Jenrette called Column Financial. Last summer, ERE Yarmouth sold its interest and formed a hybrid REIT called Chastain Capital Corp. "Chastain will originate loans, securitize those loans and then retain the low investment grade bonds through maturity," explains ERE Yarmouth's Wright. "Given where we are in the market cycle and the maturity of the business, we feel eventually people will understand why that element of interest is valuable and we will be rewarded when we do our execution."

"The owners of the hybrid REIT are not going to be your typical equity REIT buyer who is really looking for a real estate substitute," he adds. "The buyers will be more oriented toward opportunities where they can get a little bit better risk adjusted return, where they see less competition."

The effects of consolidation going on in the larger banking and insurance industries are trickling down to the point where smaller commercial mortgage banking companies have lost some of their correspondent network, adds Graafeiland. Mergers are transforming the commercial mortgage banking industry and the result, says Graafeiland, has been the emergence of the regional mortgage banking firm.

Or, the national mortgage banking firm! That seems to be the direction the Vienna, Va.-based WMF Group is willing to pursue. Acquired by NHP Inc., it was then spun off on its own last year when NHP merged with Denver-based AIMCO. Headed by Shekar Narasimhan, WMF has been on a bit of tear the last two years. In 1996, it purchased the loan production pipeline, servicing and other assets of American Capital Resource and Proctor & Associates. Last year, WMF bought Askew Investment Co. of Dallas and the Robert C. Wilson Co. of Houston (also the second-largest mortgage banker in Arizona).

"One of the things we are doing is acquiring a network of regional commercial mortgage banking firms to really build a commercial side of the business," says John Smeck, a director and senior vice president of WMF Robert Wilson in Arizona. "This is a strategy the company has been working on for the past three years, and it was one that got kicked off in the industry with AMRESCO buying Holliday Fenoglio and CB Commercial nabbing L.J. Melody & Co."

In the next three years, there will not be any more privately held mortgage banking or brokerage firms of any size, avers Smeck. "There will be some independents, but the majority of shops will all be part of some national and probably publicly traded company."

The reason? The competitiveness of the market. "You might need to look at 20 deals to get two loans closed," says Smeck. "You have to look at a lot of business because there is so much money out there chasing equity and debt deals. Everybody's revenues are up, but their profitability and margins are down."

To survive in this environment, companies need to be well capitalized. To have the production teams, support staff, technology and resources necessary to provide high levels of service means a major capital investment. Even big firms found they needed to be bigger, which explains the merger of Berkshire Mortgage Finance with Patrician Financial Group last year.

Berkshire Mortgage, as a combined company, did a record $1.3 billion in business last year. Although mostly known as a multifamily lender, in 1996 it branched out to commercial, which now makes up one-third of its production and that number is expected to increase. The company sells to conduits, principally NationsBank and Merrill Lynch.

The margins in this business are being hit hard, says Tom Szydlowski, a senior vice president and head of production at Berkshire. "Over the past few years, the margins for servicing, origination fees and every area that we make a profit is being cut back a little bit."

However, Szydlowski points out, while current business may not be as profitable as had been in the past, that doesn't mean it is unprofitable, it just means the industry has to do more business to keep the same profits going. "Spreads are being compressed, but they are not being compressed to the point where it is unattractive to originate loans," he adds. "Larger loans are more competitive, but the fees on smaller loans haven't changed."

Boston Capital Mortgage Co. , 50% owned by Llama Co. and 50% by Boston Capital, was formed two years ago for the purpose of securitizing assets. The company began business last year doing about $200 million in business. This year it expects to double the volume.

Boston Capital doesn't intend to challenge the movers and shakers of the industry, hoping instead to be an effective niche player, says Kingsley Greenland, president. "We will continue to grow but to the $1.5 billion to $2 billion level. Being a small player, however, is a risky gamble. The question for smaller shops is whether they can hang around long enough to be recognized for their underwriting quality. It is tough to compete with companies who are originating $6 billion to $8 billion a year."

Even being large doesn't guarantee success, Greenland adds. "You absolutely have to run faster. At some of the larger shops, I'm frankly not sure how their profit margins are doing or whether the companies are just going for servicing. But you must run faster to keep up with growth. There will be shake-ups in profit margin."

If companies don't watch expenses, they could find themselves in a difficult position this year, adds Greenland. "If you don't watch your underwriting criteria and you get bad subordination, you can be in difficulty. It was easier to make money last year because the Feds were moving in the right direction and you didn't have to be smart. All you had to do was originate the product and since the spreads were compressing, you were OK. It is going to be much more difficult to make money this year."

Credit lease showing high demand Capital Lease Funding, a New York specialty lender that only finances properties net leased to credit tenants, is another company that was formed within the past few years. It opened for business in 1995 and by the following year was fully ramped and lending. A direct lender, Capital Lease holds a $550 million warehouse facility with NationsBank. "When we have enough loans, we pool and securitize them, which of course will refresh our warehouse capabilities," says Paul McDowell, a senior vice president in the company's New York office. So far, the company has just securitized one pool for $130 million, and that was done last year.

Within the credit lease marketplace there is not a significant amount of product. It is not like a conduit, explains McDowell. "These loans have to be very carefully underwritten as they are characterized by low-debt service coverage and they are dependent upon the quality of the lease from the credit tenant. While there is room in the marketplace for several competitors to do well, it is not a place where the big conduits or other people who are not devoted to this particular market are going to do well." Credit Lease's competitors include Daiwa, First Union and WMF.

Despite the small number of players in this market, McDowell says there is not enough product, which is often a complaint heard about the commercial markets in general - that there is a lot of capital, but not enough good product. In McDowell's sector, not only isn't there enough product, but also not enough expertise to handle what is out there. And whatever is out there is uncertain because credit net lease is still a relatively untapped market.

ARCS Commercial Mortgage Co. L.P. might also be considered a 1995 company, but its history is a little more complicated. Harold Levine started the company in 1971, then sold it to Empire National Bank, which was eventually acquired by Bank of New York. In 1995, the bank re-evaluated its mortgage banking division and sold off the residential portfolio. Levine bought the commercial portfolio and, in 1995, ARCS was back as an independent company. That year it closed mortgages for $60 million, the following year, $500 million and in 1997, $752 million. This year, ARCS expects to do $1 billion.

For the year ending 1997, ARCS' servicing portfolio grew to just over $2 billion, a 25% gain over the prior year. When it was still part of Bank of New York, ARCS was the No. 1 Fannie Mae DUS servicer. It has yet to relinquish the title.

Although he has had fast success since taking his company independent, Levine recognizes ARCS, based in Calabassas Hills, Calif., is at a crossroads.

It has been able to expand by opening new offices and now has 13 across the country. Two more should open up this year. "I am very committed to this approach to business," says Levine. "We have more loyal customers, better quality of work and better control over what we do." Levine has looked at acquiring existing local companies instead of opening new offices, a method that has a lot of front-end expense, but he believes it costs as much to convert an existing office - sometimes more if the office is saddled with a lot of deadwood.

Still, to survive ARCS may need to get a lot bigger fast. "There are a lot mergers going on in the mortgage banking arena, especially in commercial mortgage," Levine adds. "We are strategically looking at our options including acquiring other big companies. We are knocking on people's doors, and others are knocking on our door."

PW Funding is another company that became independent after being spun off from a larger firm, in its case PaineWebber. Based on Long Island, the Fannie Mae DUS lender has offices in Los Angeles, San Francisco, Chicago, Dallas and Jersey City. Last year it did about $300 million in loans, a number it should repeat this year. Strictly a multifamily lender now, the company is diversifying into commercial as well.

"Multifamily is probably the worst sector in terms of competition," says Robert Walsh, a PW Funding managing director. "Not only do you have government agencies such as Fannie Mae and Freddie Mac, but you have all the conduits, life companies active as multifamily continues to be the preferred asset class." One result of all this competition is that in securitization programs, multifamily sometimes is used as a loss leader in pools, Walsh says. "Multifamily is priced very aggressively and it is hoped yield loss on originations can be made up with other asset classes."

While most companies say 1997 was a fantastic year, Todd Schuster, chairman of Continental Wingate, quite frankly admits 1997 was just OK. The FHA, Fannie Mae and DUS lender based in Boston also boasts a conduit program, which works in conjunction with Credit Suisse First Boston. It's not that business was bad in 1997, but the company recognized the changes occurring in the industry and altered its own game plan. In the past, the company's production system was almost entirely based on third-party correspondents, but Schuster felt that wasn't strategically wise and last year the company decided to bring on a sales force. Since June 1997, Continental Wingate has hired 45 people and now has offices in Atlanta, Seattle, San Francisco, Phoenix and the Washington-Baltimore corridor. Part of the new hires were in fact the result of acquiring small, local mortgage companies.

"To date we haven't made any major acquisitions," says Schuster, "but clearly we are trying to position ourselves with this new business plan to be one of the handful of survivors in this industry." Schuster predicts the industry will reposition and consolidate. "Ultimately, over the next two years you are going to see five to seven companies emerge as primary players."

To be a survivor, Schuster says this is the time for his company to reaffirm its commitment to the business by staffing up, committing resources and adding MIS technology. "Although margins are slim right now and there is a lot of competition, if we set ourselves up right, two years from now we are going to be big winners."

This year, Schuster says, will be a banner year for Continental Wingate as loan production will pass the $1 billion mark.

CMBS breaks records CMBS ended last year hotter than a firecracker with a record $44.3 billion in securitization. But that was only a prelude to bigger and better. The market pitched up a couple degrees more. In the first quarter alone, a scorching $19.6 million worth of CMBS came to market. (Just three years ago $19 million was annual output.) A survey by Commercial Mortgage Alert found that more than $23 billion in offerings was on tap for the second quarter, which means that volume in the first half of 1998 alone should approach last year's record total.

The volume of commercial mortgages that rolls over each year totals between $120 billion and $140 billion, and the ceiling in the market should be about 80% of that, says Sheridan Schechner, a managing director at Goldman Sachs. "The 80% number comes from the amount of securitization in the residential sector. It may not be the best analogy, but it is the best we got. At that level, the ceiling could be $96 million to $108 million."

Most projections for this year begin at the $70 million level, so there is still plenty of room for growth.

Not only is total volume ballooning, but individual deals are getting bigger as well. Any deal less than $1 billion is beginning to look puny. Multibillion dollar transactions may not yet be the norm, but they are not all that unusual either. Already this year, Nomura came to market with a $3.7 billion offering. Lehman Brothers, First Union and Bank of America will be getting together for a $3.5 billion transaction in the second quarter. Other major deals coming up include a $1.6 billion Lehman securitization; $1.6 billion Goldman Sachs; $1.5 billion GMAC, Deutsche, Lehman; and $1.5 billion Credit Suisse First Boston. In fact, there are at least a dozen deals of more than $1 billion scheduled for the second quarter.

"When you look at corporate bonds, a billion dollar deal happens occasionally, but it is still a bit of an exception," notes Michael Mazzei, who heads up CMBS at Lehman Brothers. "In CMBS, the market has grown so much that anything below $1 billion is considered small."

Evolving of the CMBS buyers The buyers of CMBS have almost become money managers of mutual funds because they are using the product as a substitute for corporate bonds. As deal size has gotten larger, liquidity better and because core protection has become solid meaning prepayment prohibitions are strengthened, buyers can use CMBS as a way of beating the corporate bond indexes. "A lot of these guys are buying CMBS not as a substitute for the single-family mortgage product, but as substitute for corporate bond product," says Mazzei. "With CMBS they can get AAA-rated product at 80 over in our market and AAA in the corporate market at 25 to 40 over so, in many cases, they are doubling the spread and it has become very attractive."

In addition, a lot of insurance companies are using CMBS as a real estate proxy instead of doing loans at 70 or 140 over on mortgage assets which demands a lot more capital and requires a lot more people.

Mazzei should know what he's talking about when it comes to CMBS. For four years running, Lehman Brothers was ranked No. 1 in CMBS underwriting. In 1997, CMBS did $9.4 billion in CMBS. (Lehman is also one of the top lenders in the country, having originated $13.1 billion in commercial real estate loans last year.) So far this year, Lehman is in a horse race with Morgan Stanley as to who's No. 1 in CMBS underwriting. Lehman did $2.2 billion in the first quarter, while Morgan Stanley did about $7 billion. But, Mazzei says Lehman should do $5 billion to $6 billion in the second quarter which should close the gap.

This surge in CMBS will continue, predicts Mazzei. "Real estate assets, whether debt or equity, are being priced in the capital markets and will continue growth at a rapid rate," he adds. "As the CMBS market expands, the private lenders will continue to lose marketshare as investors will continue to look to CMBS which is more liquid, better priced, takes less infrastructure and demands less capital to buy."

Conduits must understand changes The second thing that will happen, Mazzei adds, is that conduits that don't come to market often enough are now learning that some of the stuff they did last year very aggressively is going to be much less profitable. "A lot of these guys that come to market once a year don't have a clue as to what is going on," Mazzei says. "Their last impression of the market was a year ago. So, there are a lot of guys out there with their loan to value going up and their spreads getting tighter on the origination side. They weren't keeping track of the fact so much volume had come to the market and investors are requiring higher yields and are more aggressive and support levels from the rating agencies were going up."

Returns are beginning to reach normal levels, claims Heller Financial Real Estate's Goldsmith. "These normal levels are the returns that one enjoys at a finance company as opposed to the type of returns that one enjoys being a trader on Wall Street."

Heller Financial Real Estate is part of Heller Financial, a $12 billion commercial finance company. Real estate has been a $2 billion volume business of Heller Financial, operating out of 11 offices nationwide. The company underwrites, closes, packages and securitizes its own real estate loans. Last year, it originated about $1.5 billion on the conduit side of its business out of $2 billion in total activity. Recently, Heller did a $1.1 billion securitization with Morgan Stanley and is on track to do $2 billion this year.

"It was very easy to enter the conduit business based on the assumption that if you did $300 million or $400 million of volume in a year, then you would get an adequate return for your investment," explains Goldsmith. "Today, the scale isat least $1 billion. So anybody who is originating less than a billion dollars on a stand-alone basis is having a hard time covering their costs. The threshold has been raised considerably as margins have gotten tighter."

The fixed-rate, conduit type loans for immediate securitization is extremely competitive and everybody is going to get squeezed on that, adds Louis Mirando, managing director and chief executive officer of TransAtlantic Capital Co. in New York. "It has become just a commodity."

The key to surviving in the CMBS business, Mirando suggests, is to not be just a conduit lender. TransAtlantic products include not just the fixed-rate loans, but mezzanine financing, participating loans and even construction loans that it holds on its books for three or four years. "You really need to become a sort of full-service real estate finance company because you need to incubate deals and not rely on mortgages to be profitable," Mirando says.

TransAtlantic was formed about two years ago as a joint venture between Deutsche Morgan Grenfell and a group of investors. Today, it is a direct originator of partial mortgages for Deutsche Bank. Last year, TransAtlantic did about $1 billion in originations, and this year it anticipates closing $2 billion in fixed-rate and floating-rate product. In March, Deutsche Morgan Grenfell did a joint $1.58 billion securitization with Morgan Stanley (including TransAtlantic loans) and is now working on a $1.7 billion deal.

The CMBS business is beginning to resemble the residential phenomenon, says Mirando. "What happens is, the margins in the business decrease and volume becomes important. The people who stay in this business are those who can integrate other aspects of business and dovetail it all with the original platform. We see emerging out of the pack, four or five dominant forces that will do a lion's share of the origination business."

Everybody else who wants to hang in there will do so as a niche player - which isn't a bad way to strategize. Another company that has found a successful niche is Daiwa Finance Corp. in New York.

Daiwa boasts a full-service real estate finance department that, in format and structure, is set up similar to Nomura, explains Frank Keane, a managing director. "What we do is go after the higher-margin business - we do have a conduit business but that is just 50% of what we do. The other 50% is made up of bridge loans, credit tenant lease loans and nonstandardized product." Daiwa does its own warehousing as the nonstandardized loans are not immediately securitized.

Last year was a good one for Daiwa, Keane recalls. "Even the conduit which we thought would be on the lower end of the profitability spectrum ended up being very profitable." Originations in 1997 totaled $1.6 billion and that should increase to $2 billion in 1998. Daiwa did only one securitization last year valued at $250 million, but in 1998 it has already completed two amounting to just over $1 billion. "1998 will a record year for us," Keane says. "Now we are rolling."

In Keane's view of the marketplace, the biggest conduits buy marketshare and then wait for all the other guys to exit the business so they can then widen spreads. Margins have gotten to the point where it isn't making a whole lot of sense for everyone to be there. "What happened was, Daiwa essentially stepped back and focused on the higher margin business at that point," Keane says. "Other companies have a conduit group which seeks to justify its existence and put money out at almost any spread. We don't have to do that. We have underwriters and we are very flexible. We held our ground on the upfront spreads; we were charging at the expense of the portfolio. But, at the end of the day, we still had a portfolio with a lot of margin in it."

Conduits, lenders and services have adopted myriad strategies to compete in the CMBS free-for-all but, in the end, only consolidation will resolve the fracas. Some of that has already begun to happen as witnessed by PNC Bank's acquisition of Midland Loan Services L.P.

Midland, a Kansas City-based originator, securitizer and servicer of commercial mortgages, was at the point in its evolution where it felt it needed to access additional capital in order to continue its growth. Given all the consolidation, increased competition, tightening spreads and lower profit margins "we needed a lower cost of funds," says Tim Mazzetti, a senior vice president. Midland determined that going public was the way to proceed and was looking forward to doing an IPO, but then PNC made an offer Midland couldn't refuse. Midland's new appellation is Midland Loan Services L.P.

Last year, Midland did about $800 million in originations and PNC $300 million. This year the combined Midland Loan Services is on track for a $2 billion year.

This is a highly competitive business, reiterates Mazzetti. "A shake-out is going to begin. If you took all the 50 conduits out there and looked at their projected securitization numbers, it would all add up to $100 billion of business this year. Even though the market is on pace to do $60 billion to $70 billion this year, we are obviously going to be significantly short of what everyone's projections are. There is obviously not enough product to go around to satisfy everyone."