Last year was unusual, to say the least, and 2002 promises to be another irregular year in multifamily and commercial real estate finance. After mediocre activity in 1999 and 2000, loan originators longed for 12 months of record fundings and a return to soaring profitability as seen in 1998. However, a sputtering economy and uncertainty in the interest rate environment prevented most lenders from breaking production records in 2001. The tragic events of September 11 dealt further setbacks to the industry, but decreases in interest rates have, in part, mitigated those effects.

Hospitality, retail and office sectors have been hit the hardest by the sluggish economy. Industrial properties remain an attractive product for long-term lenders, while multifamily and manufactured home communities continue to lead the pack with their red-hot level of desirability.

Retail

The retail sector was perhaps the greatest real estate victim of 2001. Below-par consumer confidence levels resulted in lower-than-anticipated retail sales. Sluggish retail sales in the world of income property finance have resulted in higher mortgage interest rates and a general tendency for lenders to avoid non-anchored retail developments. Lenders are inclined to be relatively selective -- even when considering institutional investment-grade, credit-anchored properties as candidates for financing.

The future turnaround of this asset class will be tied closely to an economic recovery. If this year brings about economic prosperity, consumers may loosen their purse strings, lenders may relax their underwriting standards and the retail sector will once again have ready access to capital.

Hospitality

Who continues to finance all of the limited service hotels that keep popping up along interstate highways? That seems to be the million-dollar question among long-term lenders who are increasingly fearful of this market. Very few lenders will now consider financing this product, and most will completely shy away from full service hotels unless loan requests are very conservative (below 50 percent loan to value). With very low default rates in most lender' permanent loan portfolios, generally the only category showing dangerous signs of weakness in the form of higher default and foreclosure rates is the hospitality sector. Leaders in the hospitality industry complain of lower RevPAR (revenue per available room) figures due to poor economic conditions, increased competition, market saturation and September 11.

Look for a continued slowdown in this industry and a scarcity of funds available for financing this product for quite some time. A deeper economic recession could deal a catastrophic blow to the hospitality sector as further business and leisure travel declines would be devastating to an already over-supplied market.

Office

The office market also has fallen victim to the recession and layoffs. The demise of technology industries has cooled lenders and buyers on this property type as dot-com companies retract or close shop. While not of the magnitude seen in the retail and hospitality industries, lenders are staying on the sidelines or being very selective about financing office buildings these days. A few years ago, values were inflated as buyers bid up purchase prices simply because of rosy projections related to rental increases. Values of office buildings have reduced from past years as bargain hunters seek deals in the aftermath of the dot-com collapse. The future of this product' desirability will hinge on an economic recovery followed by stabilization of technology-related business and substantial overall job gains.

Industrial

Demand for industrial product appears to be weathering the economic turbulence these days. Lender appetite seems to be strong for financing modern facilities as occupancy levels are generally high and rents continue to climb. The current strength of this sector and resulting desirability of industrial product among lenders can be partially attributed to the new "globalized" economy, which was brought about by international agreements such as NAFTA. Modern trade agreements, with less restrictive tariffs on products crossing international boundaries, have resulted in a dramatic increase in the overall value of imports and exports.

Demand for large distribution centers (500,000 square feet to 1.5 million square feet) with over 30-foot clear ceilings is strong. Lender demand seems to be equally strong; thus, owners of these facilities who seek mortgage financing are enjoying favorable rates and terms. A deep recession or a repeal of international trade agreements (a more likely scenario) could spell trouble for this product. For now, the outlook appears to be strong for financing contemporary industrial properties, particularly those located in today' gateway cities and distribution hubs.

Multifamily and Manufactured Home Communities

Multifamily and manufactured home communities continue to be the most highly coveted properties among lenders. Interest rate margins are relatively low and lenders will slash origination fees and/or absorb closing costs in an effort to win this business. This is universally true of government-sponsored enterprises (GSE), life insurance companies, banks and conduits whose love affair with this product seems to be at an all-time high. For example, Fannie Mae, which holds a 78 percent market share of the product among GSEs, had eclipsed its total 2000 production volume by July 2, 2001.

Conventional multifamily properties have experienced strong occupancy and absorption levels in most markets, and rents are generally on the rise. The only exception to the otherwise healthy multifamily industry is the elderly housing subset. This type of multifamily housing has been negatively impacted by the bleak financial condition of the acute care segment, as well as the oversupply of sub-acute product (congregate care and adult congregate living facilities), which has resulted in a slower than expected growth in absorption and rental rates.

The manufactured housing industry, once snubbed by leading providers of long-term capital, is enjoying unprecedented popularity among lenders. Look for this popularity to grow as more and more lenders recognize and appreciate the stability and growth potential of cash flows associated with this product. Fannie Mae was the latest and most noteworthy lender to become involved in the manufactured housing industry, but others will follow.

The Exceptions

In summary, 2001 was turbulent, and the first half of this year will likely be similar. The foregoing represents a very simple review of the year 2001 and equally simple projections for 2002. As is the case with any article, speech or statement of policy that attempts to achieve broad-based conclusions regarding such complex and far reaching subjects as the nation' outlook for commercial and multifamily real estate finance, there remain many, many exceptions. Some retail markets are experiencing robust times and a few hospitality developments continue record-setting trends of the past several years. On the other hand, believe it or not, overbuilding has preceded market softness and nearly zero growth in rental rates in several multifamily markets. Some of these markets have also seen rising energy and insurance costs (both liability and casualty) squeeze net operating income performance.

The simple axiom of the late 1990s, "The only mistake that a lender can make is to turn a deal down," no longer prevails. Lenders must now develop and maintain a comprehensive understanding of their markets and the ever-changing dynamics that drive their respective economies in order to make the right financing decisions.

Chris Dyson is senior vice president and co-production manager of Collateral Mortgage Capital, LLC, a national commercial mortgage banking firm headquartered in Birmingham, Alabama.


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