Maybe commercial real estate wasn’t all that risky during the Great Recession
The Mortgage Bankers Association (MBA) said in early March that during the recession, commercial and multifamily mortgage delinquencies were not all that dire. Here is a summary of the MBA’s findings:
The actual amount of commercial and multifamily mortgage debt extended and held by banks remained steady. In the case of multifamily mortgages, the year-end balance did not decline, and the balance of commercial mortgages fell just 3 percent between the peak in 2009 and trough in 2011 before rising again in 2012. By contrast, the balance of construction loans fell 62 percent between 2007 and 2012, the balance of commercial and industrial loans fell 21 percent between 2008 and 2010 before rising again in 2011 and 2012, and the balance of single-family loans fell 14 percent between 2007 and 2012.
Commercial and multifamily mortgages finished 2012 with 30-plus-day delinquency rates that were lower than the average for all of the loans and leases they held.
At the end of the fourth quarter, commercial mortgages had a 30-plus-day delinquency rate of 3.55 percent, down from 4.67 percent at the end of 2011. Multifamily mortgages recorded a rate of 2.19 percent, down from 3.22 percent at the end of 2011.
Throughout the credit crunch and recession and into 2012, commercial and multifamily mortgages had the lowest charge-off rates of any type of loan held by commercial banks and thrifts.
In 2012, banks and thrifts charged off 0.55 percent of their balance of commercial mortgages and 0.32 percent of their multifamily mortgages, compared with charge-off rates of 0.84 percent on commercial loans and 0.74 percent on multifamily loans in 2011.
In aggregate dollars, the charge-offs of commercial and multifamily mortgages by banks and thrifts also remained far below those of other loan types during the recession.
From 2007 through 2012, banks and thrifts charged off $212 billion of single-family mortgages, $205 billion of credit card loans, $95 billion of commercial and industrial loans, $85 billion of construction loans and $72 billion of other loans to individuals.
Over the same period, they had to charge off $41 billion in commercial mortgages and $8.5 billion in multifamily mortgages.
Bill Kuzy sees the commercial loans coming from all directions: pension funds, insurance companies, banks and credit unions.
Real estate is popular again, providing it is the right property, in the right location, and at the right price. Conventional lenders, such as banks and credit unions, have returned to commercial real estate. So have insurance companies, pension funds and high-net-worth individuals.
“For all intents and purposes, the institutions I work with are all back at it,” said Bill Kuzy, founder and president of Iowa Commercial Mortgage Inc. in Urbandale.
Some of that might be cautious money. Builders and real estate brokers say there still isn’t a lot of cash available for construction and development.
And the money that is financing purchases of existing properties, although relatively inexpensive to obtain, often needs to be balanced by a large equity stake from the buyer.
Evidence of more lending
The fact that lending is on the rise can be measured on many fronts.
Iowa banks increased their aggregate loan portfolios last year by $1.2 billion to $43.9 billion. John Sorensen, president and CEO of the Iowa Bankers Association, said the majority of those loans were commercial and industrial loans. He said that, as with banks across the nation, Iowa lenders are reluctant to provide money for development and construction projects.
And though overall lending was up last year in Iowa, it lags the peak of nearly $45 billion that was reached in the fourth quarter of 2008.
Eric Lohmeier, managing director of investment banking firm NCP Inc. in Des Moines, said the number of lenders on the prowl for commercial projects has risen dramatically in the past six months.
“There’s been a sea change in the last six months, to the positive on commercial real estate,” Lohmeier said.
Return on investment is the big draw. A real estate investment with a return of 4 percent beats a return on bonds of 2 percent, Kuzy said.
“The returns on bonds are so paltry; commercial mortgages still give them good values,” Kuzy said.
Another indicator is that institutional investors such as life insurance companies and pension funds want to increase their real estate portfolios.
“In general, pensions, endowments, high-worth individuals are considering elevated allocations (to real estate),” said Todd Everett, managing director and head of real estate fixed income at Principal Real Estate Investors.
In Greater Des Moines, the big lenders are banks: the big nationals such as Wells Fargo & Co., the regional lenders and local banks.
Little fancy stuff out there
Loans are pretty straightforward – there is not a lot of expensive mezzanine or gap financing being used to help borrowers fill in the difference between their equity and the amount of financing lenders will provide.
If the loan is from an insurance company, that gap can be fairly broad. Everett said that loan-to-value ratios are at a 45-year low, with insurance companies frequently wanting 40 percent borrower equity in a deal.
Debt service coverage ratios, which measure the amount of cash flow a property generates or other assets that can be used toward loan payments, also are high, reaching a high of 2.25 in the third quarter of 2012 before declining slightly in the fourth quarter, according to the American Council of Life Insurers (see graph p. 7)
However, life insurance companies and other institutional investors loan their funds at interest rates several percentage points lower than rates charged by banks, Kuzy said.
Financing for those loans is attractive if a borrower wants to sit on a property for 15 to 20 years – institutional lenders typically have fairly severe early payment penalties. Still, the loans generally are secured by property and not the personal guarantees of borrowers.
Banks, on the other hand, generally want to be into a project for a shorter period of time on a fixed-rate loan. They also tend to back up those loans with personal guarantees from borrowers as well as mortgaged property.
Though the loan-to-value gap from life insurance companies is broad, Kuzy said he sees some financing that is made at up to 70 percent of total project costs, and higher in some cases.
What deals do lenders like?
“Depending on the property, they’ll stretch more on certain deals, such as multifamily and good quality industrial,” he said. “On multi-tenant office and retail, they are more conservative, but on a good strong retail center, that’s not to say you can get decent leverage.”
The key to securing financing is to bring “smart deals” to the table, said Kyle Gamble, senior vice president and managing director at CBRE/Hubbell Commercial in West Des Moines.
Such deals “make sense from a location standpoint, from a pricing standpoint and from a timing standpoint,” he said. “Is there demand? Is it the right fit? Is it sustainable? Will the borrower be able to pay back the lender?
“You have to do your pro forma, you have to do a feasibility study,” he said. “We like to have independent third parties do analysis, especially in multifamily housing. You have to make sure the demand is there and the project is justified.”
Forget speculative projects.
“Anything speculative right now, especially in the office market, there is not enough demand and such a significant supply, that justification for a new spec office just doesn’t work. That’s where that timing analysis comes in,” Gamble said.
Kurt Mumm, president of NAI Ruhl & Ruhl Commercial Co., said lending conditions have loosened, but are not wide open.
“Different banks have different sweet spots,” he said. “You’ve got some who still have an aversion to retail or office. Everybody is comfortable with industrial.”
Banks typically will provide 75 percent of the financing for a project, up from 65 percent a year ago, and some “will drift higher on better properties, going to 80 percent,” he said.
Banks also are more aggressive on refinancing, Mumm said.
Refinancing drawing fresh capital, creative ideas
Principal’s Everett pointed out that several billion dollars in commercial mortgages are resetting, many of which need new sources of capital.
“In a lot of cases, existing sponsors are contributing new equity capital,” he said. “Assets also are being sold to a new party who is contributing capital to pay down an existing loan.”
With insurance companies lending at levels near their historic lows, gap financing through additional debt can be a good investment, with yields running 6 to 10 percent, Everett said.
Part of the challenge in the refinancing is that property values have not fully recovered from the recession.
“We have recovered considerably from the trough, but we’re a little over halfway back at this point,” he said.
Leo Skeffington manages the restructuring and real estate divisions at NCP Inc. He said lenders have become much more aggressive in refinancing commercial real estate. As an example, a lender on an out-of-state project agreed to take a $1 million discount on a loan in order to sell it to another bank that restructured the debt with a relatively low debt service coverage ratio, saving the borrower about $600,000. That savings essentially became the borrower’s equity in the deal.
Missing in the Greater Des Moines market is the mezzanine or gap financing that is needed to fill the void between a project cost and the amount any lender agrees to finance.
There just aren’t a lot of the $100 million projects that typically need that type of financing. The lack of those deals also accounts for the predominance of banks in the local lending environment.
“We hit mostly singles in the metro area, so the banks are the primary players to fill that need,” Gamble said. “But we hit a lot of singles.”