FEATURE ARTICLE, FEBRUARY 2010

MIDWEST COMMERCIAL LENDING UPDATE
Experts forecast continued challenges in the commercial lending market, but some loosening of the credit crunch is expected.
Amy Bigley

Investors, developers and owners continue to search for new ways to finance or refinance projects throughout the Midwest. The overall market is still tight; however, there are options for the determined and well-positioned borrower. First, it’s important to understand the market’s current challenges, dispelled myths and learn the best tactics for obtaining the needed financing. Heartland Real Estate Business spoke with two lending firms, Walker & Dunlop and Kennedy Funding, to gain insight about the 2010 commercial lending climate.

Challenges

The commercial lending industry still has an uphill battle in 2010. Lenders will continue to have difficulties with property valuations and thus financing. Property valuations provide assessments of the market price at a single point in time, allowing accurate financing offerings. “The abundance of foreclosures and distressed assets carried over from 2009 has put additional strain on this already uncertain estimate,” explains Kevin Wolfer, co-CEO of Hackensack, New Jersey-based Kennedy Funding Inc. In addition to this uncertainty, the market has been flooded with properties that were sold at distressed prices, which leads to devalued comparable market analyses or comps.

The combination of these factors will make obtaining financing difficult for developers. Commercial loans from traditional lending sources, such as banks and government-backed institutions, have decreased 90 to 92 percent in the past year. On the upside, alternative financing sources have come to the forefront to bring financing options to developers in need of cash.

Another challenge in the year ahead is limited sources of capital within the conduit market. The conduit has been reduced for the past 18 months, but conduits are expected to start to re-emerge as the year progresses; however, rates will continue to be in the excess of 7 percent. “[This re-emergence] will provide needed relief to office, retail and other major commercial property types that have historically relied on conduit financing,” says Vic Clark, senior vice president – central regional manager with Walker & Dunlop’s Multifamily Finance division in Plano, Texas.

Additional trends that are rolling over from 2009 include tighter underwriting constraints for nearly every source of capital and a continued bid/ask gap, albeit shrinking from last year’s highs.

Myths

The recent highs and lows of the commercial real estate industry have generated much myth and legend, which should be dispelled with the new year. One pervasive myth is the doom and gloom perception of surrounding the market. “This negative depiction of the current market is overblown,” notes Wolfer. “That is not to say that there is not a dark cloud shadowing the commercial sector; however, the doom and negative perception has become excessive and prevented investors from re-joining the market.”

The notion that banks are not lending is also misleading old and new investors alike. Although there have been many bank closings, strong regional banks are actively acquiring failed banks from the FDIC and are looking to grow customer bases and loan portfolios. “Your old lender may not exist anymore, and is most likely operating under a new flag with new faces,” explains Clark. “It’s a great time for borrowers to make new lending relationships.”

The tales that Fannie Mae and Freddie Mac will disappear and securitization will not return also should be rebuked. Fannie and Freddie continue to provide stable financing options for the country’s multifamily and single-family housing market. Additionally, securitization never left the marketplace. Fannie and Freddie are utilizing and moving to more of a securitized model with respect to MBS trades and CME products, notes Clark. Conduit lenders are also set to return in 2010, which will keep downward pressure on rates for the near term.

Credit Movement

The end of the third quarter of 2009 marked a slight loosening of the credit market. However, the market will not bounce back to normal lending practices over night. During the next 15 months, more than $3 trillion worth of commercial mortgages will mature, resulting in developers and contractors looking for refinancing options, notes Wolfer. This need for refinancing should loosen the market further. The downside is that many borrowers will no longer quality for traditional loans and will be turning to financing through alternative sources, such as hard money lending. The underwriting market has yet to experience any slack in the rope. Loan-to-value ratios have come in and DSC requirements have gone up resulting in appraisers becoming very conservative. Deals continue to be made despite the tightened market and extra scrutiny.

Pushing Ahead

Interested borrowers and investors should take advantage of the current opportunity to form new relationships with new or re-organized lenders. Companies should also explore alternative financing options, such as private lending institutions. While exploring these options, investors should have realistic absorption rate expectancy that is in line with current market conditions and sales prices; understand the adjusted property values; and keep in mind that cash is king—strong equity positions allows lenders to lower risks and lend more dollars.

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