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COVER STORY, AUGUST 2007
LENDING CLIMATE CHANGE
Lenders and investors adapt to cooling off period.
Daniel Beaird
Amid recent concerns of the fallout in the sub-prime single-family lending market, most property sectors in the commercial real estate market have maintained solid fundamentals and a good outlook for the future. Primarily due to the historical amounts of capital still available to commercial real estate owners, investors remain relatively aggressive, but have been a little more cautious in recent months regarding Class B properties. As investors begin to take a wait-and-see approach on Class B properties, the CMBS market, which has been a leading source of capital for the past several years, has cooled, allowing life companies to reassert themselves as leaders in the commercial finance market.
“Life companies never got as aggressive as CMBS providers in their underwriting practices,” says Al Moczul, a principal with Tavernier Capital Partners in Jacksonville, Florida. “So, they’ve been very consistent because their standards and underwriting criteria haven’t changed during the recent months like the CMBS standards.”
The slowdown in the debt side market has not deferred investors’ interest from buying properties to flip quickly. Wanting to keep as much flexibility as possible with regard to financing these properties, investors are seeking shorter term loans or loans with flexible pre-payment penalties.
“Lenders are taking a more conservative approach to structuring deals during recent months,” says Jeff Patton, managing director of Collateral Real Estate Capital in Birmingham, Alabama. “They are less likely to quote loans with maximum leverage and pair that with interest-only payments for the entire loan term, a structure that was very common last year as well as earlier this year.”
According to Patton, that resulted in numerous properties being financed with debt service coverage ratios below breakeven if amortization was included.
“Lenders may still do a deal with full-term, interest-only, but will likely size such a deal at a level in which the underwritten debt service coverage ratios are above breakeven when amortization is included,” Patton says.
“There’s more equity involved today,” Moczul says. “Investors like to minimize their equity if they can, but with CMBS providers seeking less aggressive terms, it usually means the investors have to provide more equity.”
Abel Montuori, executive vice president and senior lending officer of U.S. Century Bank in South Florida agrees. “In a relatively soft market, lenders become more conservative,” Montuori says. “From a lender’s perspective, you want your developer to have a greater equity position and more invested on the deal.”
Moczul points out that the CMBS providers were stretching beyond their historical norms a few months ago in terms of how much debt they were comfortable placing on a commercial property. Today, the debt side is just returning to more normal levels.
“Initially, when a particular CMBS issuance doesn’t go well, lenders tend to over react and become very conservative,” Moczul says. “Then the cycle trends back to more normal terms.” Moczul doesn’t forsee the debt side stretching beyond its reach again anytime soon nor does he predict the market getting much tighter than it is today.
“It’s leveled out,” Moczul says.
As the lending climate faces a change in altitude, a big difference is the way in which non-stabilized assets are viewed by investors. In recent past years, CMBS providers structured many deals based upon the future performance of a commercial property. Today, lenders are more cautious.
“Some of those future performance deals are getting kicked out of securitizations in recent months,” Patton says. “One of [Collateral’s] major life company lenders has even stated that it is no longer considering deals in lease-up, which has been one of its historical strengths.”
While it may be too early to predict if this is a long-term change or a temporary reaction, Patton says it does offer an opportunity for mezzanine players or shorter-term capital providers such as banks to take a firmer grasp of the market.
As lending climates fluctuate, Montuori advises lenders to know everything about the deal.
“Analyze the submarket and know it very well before you jump into new construction, and know your client and client’s capacity for the deal,” Montuori says.
Whether the sky is falling or the market is just leveling itself out, investors and lenders are still optimistic about all commercial property types in the Southeast. Even as the multifamily market takes a hit in Florida due to the price of land, investors based in that state are reaching out to other markets in the Southeast to find good multifamily deals. And the lenders are following them.
“If the developer isn’t building for-sale product in Florida, which the for-sale condominium market is weak across the state, it isn’t worth it,” Moczul says. “There is land available in Florida, but the sellers are sticking with some high prices that the developers can’t make work for rental developments.”
So, Moczul says that some of Tavernier’s Florida-based clients have been reaching outside of the state for multifamily properties.
“Cap rates in Florida are so aggressive from a buy standpoint that some investors are looking elsewhere, like in the Carolinas and Georgia, for better yields,” Moczul says. “One or 2 years ago, some of the price points in Florida might have been achievable, but not today.”
So, Florida-based investors expand their boundaries. “The best multifamily market in the Southeast is Raleigh, North Carolina, with its tremendous job growth,” Moczul says.
While investors might be looking anywhere but Florida for multifamily properties, other property types are thriving throughout the Southeast as office, retail and industrial all show solid fundamental signs.
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