Canadian mortgage quote

Conservatism is key for commercial banks, pension funds and insurance companies creeping back into the commercial real estate lending market. Meanwhile, financing vehicles such as mortgage securitization and real estate investment trusts are picking up speed because they divide risk.

The slump continues. The traditional players in the commercial real estate financing market -- commercial banks, pension funds, insurance companies -- are still largely sidelined, participating in far less, if any, lending activity than they did in the vigorous 1980s, and those who are making loans are doing so in the most conservative of ways and with the most stringent of standards.

Despite all of the constraints, a few bright spots are beginning to show on the horizon. Some loans are being made, with multifamily projects, shopping centers and industrials receiving more favorable treatment than the overbuilt office and hotel sectors.

The increased activity in commercial mortgage securitization is providing an alternative to the dearth of traditional lending and opening up commercial real estate to a broader and deeper group of investors, dividing up the risk and providing about the only source of capital for borrowers seeking large sums.

Yet the regulatory requirements and pressures on banks regarding real estate loans, the overbuilt markets that aren't going to disappear overnight and the continuing national economic downturn all combine to keep capital scarce and make borrowing far more difficult for all but the best of projects.

"We are seeing a little improvement in the conventional lending arena," reports Michael DiGiacomo, director of finance at Jones Lang Wootton USA in New York.

"Some traditional players have left the game for good, but other lenders who temporarily withdrew seem to be back in the market, seeking to make good loans. The key is very conservative underwriting," DiGiacomo says.

"There are signs that indicate some institutions have renewed interest in at least reviewing new loan requests," confirms Robert P. Corso Sr., president of Robert P. Corso & Co., a Manhattan-based real estate mortgage brokerage firm "There are significant pools of capital prepared to enter the market when appropriate opportunities can be found. People aren't saying no to deals, they just aren't saying yes as quickly."

Corso says that a number of small- to medium-sized life companies and a handful of foreign banks are willing to discuss conservatively underwritten transactions. But he also reports that "the most disturbing aspect of the current credit crunch is that no significant new sources of mortgage capital have stepped forward to fill the void left by the institutions." He sees credit companies as the most suitable replacements. "Until recently these companies were at a competitive disadvantage. Their rates and terms were less attractive to borrowers." But Corso points out that these credit organizations are not regulated to the same extent as banks and not rated as are insurance companies and can thus better fill the lending void.

But a void still remains in traditional lending.

"No one wants to compound their exposure to real estate. There isn't much appetite for real estate risk," says Mark Teitelbaum, managing director and head of the Debt/Equity Advisory Division at Julien J. Studley, New York. There is so much focus on workouts, Teitelbaum says, that lenders' time and attention is diverted from making any major new deals. "It takes more time to do a $2 million workout than it does to do a $30 million deal," he says.

"The Japanese are still out of the market, as are the American banks. European and Canadian banks are looking at deals, but it is very difficult to get financing for an office building," he reports, with lenders willing to give only 30% to 40% loan-to-value.

Teitelbaum does note, however, a lot of refinancing activity by insurance companies and pension funds for retail properties that are "pure cash flow deals" and for "the safe haven" of apartment complexes. "But neighborhood shopping centers or office buildings are very difficult," he says.

Pension funds have moved away from equity and are cautiously looking at new mechanisms for their capital, Teitelbaum says, and are served better by debt, with 9% interest rates and expanded spreads.

Teitelbaum says he is "slightly pessimistic" about the near-term future of the market, as there still is a shakeout of some developers and because rental rates are not rising, both serving to further depress values. He says he is hopeful, however, that perhaps next year, if rates stay low or dip, developers may be better able to pay down their debt and try to acquire new properties. "But in the short term there is no overnight solution," he says.

Due to the tremendous oversupply of commercial space, an overall price correction must occur before "capital flows necessary to facilitate transactions can begin again," reports William B. Brueggeman, consulting director of real estate research for Goldman Sachs.

In a recent report on the impending correction in the commercial real estate mortgage market, Brueggeman points out that "$340 billion of commercial real estate loans are expected to roll over by 1993, and $185 billion of such loans will be subject to extensive repricing," due to the general decline in values, which Goldman Sachs estimates at approximately 30%.

Repricing commercial mortgage debt can be accomplished in a number of ways, according to the Goldman Sachs report. "It can be done unilaterally by lenders, or in conjunction with workouts, loan sales, loan swaps, through mortgage securitization, or by foreclosure and subsequent sale of OREO (other real estate owned). In cases where lending institutions have failed, mortgage repricing is effectively carried out through liquidation activities of government agencies."

The Goldman Sachs report goes on to advise that since a substantial amount of the repricing will occur in the next two years as construction miniperms and bullet loans are scheduled to roll over, lenders should "strategically position themselves now for this market correction."

But DiGiacomo of JLW says he doesn't think the drop in values has as yet been reflected. "Someone will have to eat the difference. Where is the money going to come from? No one seems to be addressing the problem," he says.

Goldman Sachs recommends that both performing and non-performing loans be reviewed for the possibility of undertaking mortgage-backed securities offerings, mortgage sales and/or swaps, pointing out, as are many others in the field, that recent securities offerings by the RTC and institutional lenders have shown increasing market receptivity for such investments.

"The market for all commercial mortgage-backed securities will continue to grow during the next three years," according to the Goldman Sachs report. "The volume of asset liquidations by lenders and government agencies in the coming years will eventually result in more standardization and uniformity in valuation and ratings. We believe that a viable secondary market for both commercial mortgages and mortgage-backed securities will develop as a by-product of current RTC liquidation activity and future FDIC activity, which will be undoubtedly growing," the report concludes.

Carl Kane, managing director of management advisory services for Kenneth Leventhal & Co. in New York, reports that certain "spot" loans for existing projects are being done traditionally, as well as some refinancing activity. "But by and large, people are not getting financing. It is not a reliable market."

Most traditional lenders are now preoccupied with getting their existing portfolios in shape and rolling over their current loans, which is a damper to aggressive new lending, Kane says. "S&Ls are out. Commercial banks are locked out of the market, and the insurance sector is yet to feel the pinch, and will no doubt be under more regulation as their problems unfold. Pension funds, Kane says, which have gotten "pretty burnt" with equity and with many of their traditional advisers in trouble, also are taking a much more conservative approach.

"You're lucky if you pull something out of the spot market," Kane says.

Under a ruling proposed by the Financial Accounting Standards Board, banks that are restructuring real estate loans to help developers survive the current industry downturn "will be forced to writedown restructured loans to reflect the present value of the expected payments," says Stan Ross, Kenneth Leventhal managing partner.

Under existing rules, generally as long as the property's total future cash flow is sufficient to cover the loan's principal, commercial banks are not required to recognize a loss. "Under the new proposal, a creditor will not be able to avoid marking down a restructured loan, so they may be less willing to restructure and more apt to foreclose," Ross continues.