Battle fatigue. That's what borrowers and lenders are feeling these days as a deep recession and persistent credit crunch maintain their stranglehold on the economy. Once awash in debt capital, the commercial real estate community is increasingly in search of it. With real estate fundamentals declining, lenders' purse strings will likely become even tighter in the months ahead.

Commercial and multifamily mortgage originations fell 70% in the first quarter compared with the same period a year ago, reports the Mortgage Bankers Association (MBA). The overall drop in originations included an 88% decrease in loans for hotel properties, followed by retail (76%), office (66%), multifamily (61%) and industrial (50%).

Originations by conduit lenders — those who pool mortgage loans into commercial mortgage-backed securities (CMBS) for sale to investors — fell 96% in the first quarter. There was also an 80% decrease in loans for commercial bank portfolios and a 66% decrease in loans by life insurance companies.

Not closing up shop

Although the economy's vital signs are weak, the commercial lending market has a pulse, insists Dave Twardock, president of Prudential Mortgage Capital Co. based in Newark, N.J. “We're open for business and making loans. There is a perception out there that nobody is making loans, and in fact we are.” The lender provided $7.6 billion in financing to the commercial and multifamily real estate industry in 2008. Its financing goal for 2009 is approximately $7 billion.

“I hear a lot of people say that the debt markets are shut down. I don't think that they are shut down. I just think that they are more conservative than many people would like, and that's because of the soft economy,” emphasizes Twardock.

Government-sponsored enterprises are among the most active players in relative terms. Fannie Mae provided $3.8 billion in financing to the multifamily sector in the first quarter. For all of 2008, Fannie provided $35.5 billion in financing.

“In the multifamily space, you have debt available with a cost somewhere around 6%,” says Twardock. “Depending on the market, you have a 70% to 75% loan-to-value ratio.”

Besides being one of the largest multifamily loan originators through Fannie Mae, Prudential Mortgage Capital has carved out a niche providing loans of $50 million and above to institutional clients. The lender recently closed a $103 million loan for a portfolio of retail properties owned by Weingarten Realty Investors. The assets include four grocery-anchored retail centers totaling more than 881,000 sq. ft. in California and New Mexico.

“That particular transaction is a cross-collateralized pool of properties, which we like. You have strong sponsorship in Weingarten,” says Twardock. “Those are institutional-quality retail centers, and they have strong sales levels.”

Back to the basics

Borrowers need to understand that lenders are reverting back to old-school underwriting terms with property performance under the microscope, says Dan Walsh, managing director of real estate capital markets for Cleveland-based KeyBank. Yet he encounters property owners with their heads stuck in the sand.

For example, some apartment owners facing maturing loans are hesitant to pursue 10-year, fixed-rate financing. They think they can sell the asset at a low cap rate in a year or two. (The lower the cap rate, the higher the purchase price.)

“We tell them that with the amount of capital that has been injected into the U.S. economy [through fiscal and monetary stimulus], by next year the issue they might face is higher interest rates if inflation fears start to kick in,” says Walsh.

Twardock urges borrowers to be realistic about leverage. Often, borrowers will need to put fresh equity into transactions to delever properties. “A lot of borrowers feel like lenders are being overly cautious. They need to understand the perspective of lenders when it comes to a market with very weak real estate fundamentals and uncertain cash flows.” It's a healthy approach, not a punitive one, he says.