FEATURE ARTICLE, JANUARY 2006

2006 FINANCIAL FORECAST: RAINING MONEY
Midwest lending professionals provide insight into the current and future state of the commercial real estate lending market as the new year begins.
Kevin Jeselnik

The commercial real estate lending environment throughout the nation has been performing well since the last recession in 2001. Many investors' confidence in the stock market was shaken at that time and money poured into real estate from coffers never before directed at real estate. The influx in capital has continued as low interest rates and high demand for properties have driven the market. Heartland Real Estate Business recently spoke with Midwest lending professionals to gather insight on the current climate and receive a forecast for the lending market in 2006.

Robert Sawitzke, Senior Vice President, KeyBank Real Estate Capital

“The Midwest mentality for developers is primarily a build or buy-to-hold one,” Sawitzke explains. “And I think that when you go into some of these other growth markets, it becomes more of a merchant build mentality, where [developers] are going to build an asset and sell it.”

Cheri Grossman, Director, Central Region, Wrightwood Capital

Though the Midwest is most often characterized as a stable market, the area is experiencing a heavy amount of lending activity that should continue throughout the new year. The excess capital in the market has created strong competition among lenders to provide loan products of all types. According to Sawitzke, “It is very competitive out there; there is just a lot of cash chasing deals. There are multiple financing sources that are coming into deals and I don't think it is going to stop anytime soon in 2006.”

Grossman echoes that sentiment, saying, “If you compare the beginning of 2005 to the end of that year, there certainly was more capital coming into the market, and I expect that for 2006 there will be more sources of capital. [The market] is competitive not only for the pricing that lenders can get on transactions, but also for the amount of proceeds we are seeing.”

One of the primary factors in this competitive market is the low interest rate environment. Obtaining loans is as inexpensive as it has been in some time, and only in recent fiscal quarters has the federal government begun to slowly increase rates. The market has yet to feel the pinch of the rising interest rates and activity is not expected to decrease significantly this year.

“I think the pace of development may slow down as interest rates rise, but I don't know if you are going to see a lot of the money [lenders are providing] dry up anytime soon,” Sawitzke notes. “I think the short-term rates are going to move up a little bit more this year; I don't think the long-term rates are going to move up. The curve is going to stay pretty flat, which means development should continue through 2006 at a pretty decent pace.”

Grossman also predicts increases in the short-term rate. “As the short-term rate increases, it will be interesting to see those underperforming assets that have short-term debt,” she says. “A very low interest rate environment has really helped those properties survive. Now, as the rates begin increasing, marginally performing assets are going to have a much tougher time meeting higher debt service demand, and that may create opportunities for buyers to come in and buy these properties.”

As for long-term rates, Grossman says, “the 10-year treasury has made it very attractive to put permanent debt on properties, so fixed-rate lending has experienced a tremendous amount of volume.”

The product that continues to drive the Midwest lending market is retail. The consumer demand for retail properties has fueled continued development, which has in turn fueled the need for loans aiding the construction of new or redevelopment projects. Grossman notes that the retail sector in Chicago is an area that provides many opportunities for lenders. “I think there will be some development opportunities for us to get involved in, as well as some assets prime for repositioning.”

In terms of vacancy, the multifamily market has been down in the Midwest, but Sawitzke notes that the apartment markets in various cities have started to firm a little but, so there may be some new apartment developments starting to occur.

Grossman attributes the weak multifamily market to the continued flight to home ownership brought on by the low interest rates. “A greater amount of renters have been able to afford buying a home,” she adds. “There might be improvement [in the multifamily market]; I hear from apartment owners that they are starting to see improvement in their cash flow.”

The office and industrial sectors have seen little investment and lending activity in most markets. Strong urban markets with significant logistic capabilities such as Indianapolis and Chicago have proved to be countertrends to this dearth of activity, but in many cities, the lack of job growth has slowed the development of office and industrial product.

Both Grossman and Sawitzke see little reason to doubt that lending activity will continue to perform as strongly this year as it did in 2005. The abundance of traditional and non-traditional capital, coupled with the still-low interest rates, should keep activity brisk as developers and property owners seek to take advantage of the positive market dynamics.

©2006 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.