The volume of multifamily and commercial real estate lending is a far cry from the frothy days of 2005 through 2007. Yet the flow of capital is growing and both borrowers and lenders are optimistic that financing will continue to improve in 2012.
According to National Real Estate Investor’s annual Borrower Trends Survey, more than half of lenders (56 percent) and 44 percent of borrowers are predicting that credit will be more widely available in the coming year. [Figure 1].
That optimism is good news for borrowers who are hungry for capital. Jury & Associates Inc. is one developer that is hoping this will be the year that it clinches financing for a $300 million 1,000-room convention center hotel in Kansas City. The developer has been hard pressed to land debt in a climate where hotels remain a tough sell among lenders. “The new construction loans are very difficult today. However, lenders are at a point where they have to start lending more,” says Ronald Jury, president of Jury & Associates in Shawnee Mission, Kan.
No one is expecting the flood gates to open in 2012. Lenders remain conservative with stringent underwriting practices in place. But lenders are increasingly returning to the table and lending volumes are set to continue to rise. The lenders polled said that the total volume of commercial and multifamily loans at their firms increased by an average amount of 10.8 percent in 2011 with volumes expected to grow an additional 12.2 percent in 2012.
“Clearly, 2011 was a very active year, on the loan origination side, as well as on the acquisition side,” says Michael Melody, executive managing director and co-head of real estate investment banking for Jones Lang LaSalle Capital Markets group in the Americas. The volume of commercial and multifamily sales transactions rose 29 percent in 2011 to reach $162.8 billion, according to New York-based Real Capital Analytics. Meanwhile, the Mortgage Bankers Association (MBA) originations index for commercial and multifamily loans hit 138 in the third quarter—the highest point since 2007. “It continues to be a favorable environment, and much improved from 2010,” adds Melody.
Low interest rates have played a key role in fueling borrower demand. “We’re working off of benchmarks that are at or near historic lows in an environment where there is still plenty of capital chasing the highest quality business,” says Melody. The one-month LIBOR is about 30 basis points and the 10-year Treasury is now below 2 percent. Factors such as the slow economic recovery and European debt crisis could help to keep a lid on rate increases in the coming year.
Market remains fractured
The big picture view of capital markets is a positive one. Market data supports the fact that more capital is returning to the market. In the second quarter, the level of commercial and multifamily mortgage debt outstanding hit an important milestone with a net gain for the first time in nearly 18 months. The volume of outstanding debt rose a slight 0.1 percent to $2.4 trillion in second quarter. The volume of outstanding debt held steady in third quarter, according to the (MBA).
Consistent with results from the 2009 and 2010 surveys, refinancing activity represents the most active lending niche. More than half of borrowers (51 percent) said they borrowed funds for refinancing in the past 12 months, [Figure 2]. Borrowing for the purpose of development was just 24 percent—well off the peak of 57 percent recorded in the 2007 survey
Yet a closer look also reveals a market without a level playing field. Financing is not available for everyone. “It is a fragmented market, which could be a result of where the money is coming from,” says Melody. Commercial banks, life companies and pension funds like commercial real estate as an investment and are increasing allocations, but there is still a flight to quality and lenders are gravitating towards borrowers with stellar credit.
As in 2010, less than half of loan requests made in 2011 resulted in a closed loan. Refinancing is the most likely to close at 44 percent, followed by acquisition debt at 39 percent, renovation/redevelopment financing at 27 percent and construction loans at 19 percent.
“The lending climate is very odd. It all depends on what bank or institution you are working with,” adds Jury. There are many lenders out there that are still building back their capital. For that reason, they aren’t interested in providing loans. “Then you have those that are back in the market doing loans at 65 to 70 percent loan to value, which is wonderful, but it is not the glory days of 85 to 90 percent loan-to-value,” he says.
Borrowers such as Jury are adapting to the “new normal” of a much more conservative lending climate marked by more stringent underwriting and lower leverage loans. Respondents indicate that typical loan-to-value ratios have improved only slightly to current levels of 69 to 70 percent compared to an average 67 percent 12 months ago. Recourse loans also remain prevalent. Lenders said that 50 percent of loans closed over the past 12 months have been recourse loans, which is only slightly lower than a year ago when lenders reported that 54 percent of loans were recourse.
Banks lead the way
Banks continue to be the lender of choice, with 77 percent of respondents reporting that they borrowed funds from commercial banks and savings institutions in the past year. Borrowers also accessed capital from life insurance firms (33 percent), private investors (24 percent), Fannie Mae and Freddie Mac (19 percent) and institutional investors (13 percent).
“The banks are starting to emerge. They need to get back to the business of lending in order to make their own revenues, and I think that will continue in 2012,” says Richard M. Gatto, an executive vice president at the Alter Group. The Chicago-based development firm expects to secure more than $100 million in new construction loans in 2012, including $25 million for a new 300,000-sq.-ft. warehouse complex in Fort Lauderdale.
Multifamily continues to dominate lending activity. When asked which property types offer the best investment opportunities today, the majority of lenders (76 percent) said apartments [Figure 3]. Risk averse lenders also like the strong property fundamentals.
It also is noteworthy that funding for acquisitions is improving. Four out of five lenders (80 percent) said they financed acquisitions in 2011. That represents a significant jump compared to the 2009 survey when only about half (52 percent) financed acquisitions that year. In addition, many anticipate that construction lending will also rise in 2012 as banks become more active.
Rate hike ahead?
The favorable interest rate environment has played a key role in the broader commercial real estate market recovery, and opinions are split on where rates will move in the coming year. More than half of respondents, 57 percent of borrowers and 59 percent of lenders predict that long-term interest rates will rise in 2012. However, respondents are less confident than a year ago when 78 percent of borrowers and 88 percent of lenders were predicting an interest rate hike.
Borrowers and lenders are less certain that short-term rates will increase in the coming year. More than one-third (41 percent) of borrowers and 49 percent of lenders expect higher short-term rates in the coming year compared to 74 percent of borrowers and 74 percent of lenders who held the same view in the 2010 survey.
“In the beginning of 2011, I would have said, ‘Lock up long-term rates as fast as you can, because we’re just not going to see these historically low long-term fixed rates for a long period of time,’” says William Hughes, senior vice president and managing director at Marcus & Millichap Capital in Newport Beach, Calif.
Market risks persist
Although optimism is returning, borrowers are well aware of the challenges that remain in the market and the potential risks that could emerge to impede the flow of capital.
On a scale of 1 to 5 with 5 representing the highest impact, borrowers rated the health of the U.S. economy as the factor having the biggest impact on borrowing with an average score of 3.8. Other factors that also scored high on the list include debt service coverage ratios at 3.6, loan-to-value ratios at 3.6 and number of lending sources at 3.4.
The potential risks, coupled with the slow recovery in the broader commercial real estate market, could explain why borrowers remain fairly evenly split on their appetite for capital in the coming year. Two in five respondents (40 percent) expect their total debt level to rise in the coming year, 35 percent anticipate no change, and another 24 percent expect debt levels to decrease in 2012 [Figure 4].
For our annual Borrower Trends Survey, NREI e-mailed print and e-newsletter subscribers with an invitation to participate in the online research conducted between Dec. 8, 2011 and Jan. 5, 2012. In addition, Jones Lang LaSalle distributed the survey to a proprietary list in early January, which generated additional responses. Combined, 186 borrowers and 136 lenders completed the survey. Borrower respondents have an average portfolio size of $328 million.