The Lending Scene
CMBS’ return brightens the picture in primary markets.
Commercial real estate’s slow but steady recovery
after the downturn has opened up a variety of “new but old” options for financing commercial properties for
the remainder of 2011. In the primary markets, a growing equity investment
appetite and new construction projects are the major signs of recovery this
year, aided by a rapidly improving debt lending landscape.
Most notably, the debt
landscape improvement is marked by the increased construction lending by banks
and the dramatic increase in commercial mortgage-backed securities lenders’ appetite — and as a result
their terms should be getting even more borrower-friendly in the latter half of
This trend is clear for
core loans in all markets, but the recovery for noncore loans, for the most
part, continues to be a tale of two cities with New York,
Washington, D.C., and
certain submarkets in California and other states seeing much greater improvement
than the rest of the country. Secondary and tertiary markets will have to wait
longer for the recovery to touch down, as vacancy levels and job growth in
those markets need to show more improvement.
The past two years saw the
banks as leading lenders for stabilized properties, but they are now being
pushed aside for the new wave of CMBS lenders and programs. A borrower cannot
find 10-year interest-only loans for 80 percent loan-to-value deals with 1.1
debt service coverage ratio — this is not 2007. But the new CMBS easily
surpasses the loan levels offered by the banks and life companies over the last
Two lending features that
continue to improve are the offering of interest-only periods for otherwise
amortizing loans, and the reduction or elimination of any reserves.
Interest-only loan offerings were largely nonexistent from 2008 to 2010, but
now borrowers are regularly getting “IO” quotes for two years to five years and even for 10
years with lower leverage. This meaningful extra cash flow for borrowers helps
to boost liquidity and economic growth.
appraisals accompanying the otherwise aggressive CMBS loans have been acting
somewhat as a constraint on the loan dollars. The recession/credit crisis
brought criticism and threats of legal action upon appraisers (along with the
rating agencies) causing them to remain cautious and somewhat backward-looking
in their valuations. Thus, a borrower expecting a 75 percent loan may actually
end up with a 70 percent loan as a result of an overly conservative appraisal.
Certain appraisers appear to be more prone to this than others.
With lower leveraged
loans, though, the life companies are still the lenders to beat. CMBS can often
compete on rate but 9 out of 10 borrowers will choose a life company over CMBS
given the more restrictive documentation hurdles of the CMBS loans.
Construction Loans Return
Anxious to get loan
dollars out, the banks have no choice but to start making more loans on
construction projects, renovation projects, and transitional situations, which
is great relief to developers who have been trying to get projects off the
ground for the past few years.
Borrowers must stomach
more recourse than in the past — that doesn’t seem to be changing in the near term — and loan
proceeds are still probably 10 percent below where they were previously on an
LTV or LTC basis. This trend should continue throughout 2011, with more banks
going farther out on the risk curve for these deals as they try to keep their
loan volume up.
Life companies also are
stepping up their construction/permanent loan programs. In the case of
apartments, for example, insurance companies realize if they wait for bank
finance projects to deliver, they will usually lose out to Fannie Mae and Freddie
Mac on the permanent loan business. By offering to come in at construction,
they can lock into apartment permanent loans at much higher rates than they can
get on a permanent refinance today.
While the life companies
are not as competitive as the banks on LTC for construction deals, they can win
business with borrowers who are not looking to max out leverage.
The mortgage real estate
investment trusts and debt funds have been steadily improving their rates and
terms. While they are not winning head-to-head against CMBS and life companies
on core deals, for secondary markets or deals with some “hair,” they can be a competitive
Private equity and pension
funds continue to have healthy appetites for existing and new development deals,
though with a steady and disciplined approach. Developers can look for their
promotes from equity sources to improve on the better located deals in the
better submarkets as the year goes on, though lesser deals will continue to
find equity more expensive and selective. Equity promotes are still a long way
from 2007 levels and the return to those levels may be a slow process.
An alternative to equity,
mezzanine debt is surprisingly more available than ever, as interest rates for
current pay and accrual mezzanine structures continues to improve. Current pay
mezzanine lenders are offering rates in the high single digits now, and accrual
mezzanine lenders are offering rates in the low double digits — even for
Gloom and Doom Still to
All of this improvement in
the equity, mezzanine, and senior debt areas appears to be setting up the
market nicely for the onslaught of loan maturities coming in 2012 to 2014. Many
of those maturities are with properties that are too highly leveraged to be refinanced
with a simple senior trust loan — even with the higher LTV levels. But the higher
LTV levels we are seeing come in to the market combined with the availability
of mezzanine debt and equity will help see that these deals get done: Next year
will likely set records for recapitalization and sales transactions throughout
What about that “second shoe” dropping that so many
pundits were predicting? Not likely. The real estate economy is awash with
cash. The worst scenario is that the current equity and mezzanine holders of
deals maturing in the next two years will suffer losses and dilutions.
Wholesale foreclosures, however, will be more limited, as most deals will find
a way to get restructured.
Where’s the risk? The greatest
risk to this soft landing would be a dramatic rise in the 10-year Treasury
notes, creating problems for senior loan refinancing and causing the mezzanine
and equity investors to rethink their underwriting analysis and projections. So
far, though, there are no signs that this type of move is on the horizon.
David F. Webb is senior
managing director of structured finance and a
principal at Cassidy Turley, based in Washington, D.C. Contact him at firstname.lastname@example.org.
SBA Expands Financing
Commercial borrowers are
now able to refinance existing loans to 90 percent using the Small Business
504 loan program, thanks to a law enacted on Sept. 27, 2010. This law brought
about major changes to the SBA’s lending guidelines, which help owners to
refinance into lower-rate, stable, long-term commercial mortgages.
Owner-occupied properties can now be refinanced up to 90 percent of the
appraised value or 100 percent of the outstanding mortgage — whichever is less.
Borrowers can use additional collateral, such as a home, equipment, or another
commercial property, as part of their 10 percent required equity.
Small business owners
primarily used SBA 504 loans to purchase commercial real estate that was at
least 51 percent owner-occupied. The funds can now be used to also refinance
properties, including debt acquired in support of a commercial real estate
project such as machinery, equipment, and leasehold improvements, plus eligible
refinancing costs and prepayment penalties.
In addition to the
refinance component, the SBA increased several of the borrowing thresholds for
the 504 program. Now, qualified companies with a tangible net worth of $15
million (up from $7 million) or less will qualify for an SBA loan as long as
their last two-year average after-tax net revenue is under $5 million (up from
$2.5 million). The SBA’s
share of the 504 loan has increased to $5 million or $5.5 million for
Initially the SBA 504
refinance program could only be used to refinance loans that were due on or
before December 2012 with a balloon payment. This requirement left out many
property owners with loans due beyond December 2012, including many of the
5+5-year loans written in 2006 and 2007 that are due for a rate adjustment this
year but don’t
have immediate balloon payments. Now, with a change published in the Federal
Register by April 6, 2011, all loans are available for refinance as long as
they otherwise meet the additional eligibility requirements.
There are a number of
requirements for borrowers to qualify to refinance under the 504 program:
• The property must have
been financed more than 24 months prior to a
• The loan has a balloon
• The borrowing business
has continued operations over the previous 24 months.
• The refinance cannot be
used to take out an existing government loan, such as other SBA 504 and 7A
loans or USDA loans.
• The loan to be
refinanced must be current for the last 12 months.
• The loan to be
refinanced must have been used to purchase real estate or fund improvements
eligible under 504 guidelines.
The SBA does not lend any
funds directly. Rather, the SBA works with certified development companies
(CDCs), which are private, nonprofit corporations. CDCs secure the second-lien
debentures, which are 100 percent SBA-guaranteed.
At present, applications
to use SBA 504 refinance funds must be approved by the SBA before the end of
September 2012. The SBA estimates 20,000 businesses could be eligible to
receive assistance with $15 billion in financing, increasing to over $30
billion with leverage offered by the banks.
— Elizabeth Braman, CCIM,
JD, president of Los Angeles-based Watermark Financial, a
commercial real estate financing firm. Contact her at email@example.com.
A version of this article appeared in the CCIM Greater Los Angeles Chapter