Polarizing Perceptions Strain Lending Activity

MBA (8/8/2008 ) Murray, Michael
With a standoff involving sellers not feeling forced to unload commercial property, buyers waiting for prices to drop lower and tighter lending criteria overtaking the market, pricing and liquidity remain primarily high and dry in the commercial real estate market.

“Lenders know that this is a perfect environment to get solid deals in the books with good sponsors and attractive spreads, but they are tightening lending criteria and increasing pricing to a point where very little is done,” said Andy Little, principal at John B. Levy & Co., Richmond, Va.

Little said that every major corporation—“from GM to GE and Fannie Mae and Freddie Mac”—focuses on liquidity, meaning fewer lenders trying to expand their portfolio and more managing to reduce exposures. He recommended banks short on cash decide to clean up their balance sheets and sell assets—perhaps at a discount—while property investors become more comfortable with quality assets and targeted returns.

“We do have lenders that are active, but cash is king and the cash available for real estate is shrinking—not growing,” Little said. “That puts a larger price on cash for developers and lenders.”

Sean O’Connell, vice president and director of real estate and structured finance at Advantus Capital Management, St. Paul, Minn., a direct lender and buyer of mortgage-backed securties, said that without “forced sellers,” owners are not going to sell into a commercial real estate market.

“Any buyer does not want to buy something today and have it go lower tomorrow,” O’Connell said. “Until people feel there’s a bottom, you are not going to get a lot of people in. But, we don’t have a lot of property on the market that has to be sold."

O'Connell said in the residential market, prices have not fallen far enough to get a lot of people buying. "We have not reached equilibrium in price there," he said. "In the commercial market, we have a resetting of prices because all of the inexpensive capital is gone. As cheap debt financing dries up, prices have nowhere to go but down, and institutional buyers have to address their return requirements and where they can get financing. It all comes down to the risk premium to the asset.”

Little said a normal commercial real estate markets includes the four C’s—clarity, conviction, cash and closings—but this market does not have one. Even without clarity, greater opportunity is possible, he said.

“Even at the depths of the Resolution Trust Co. crisis, we had motivated sellers and courageous buyers who could find cash,” Little said. “Those with cash and conviction closed on some truly unbelievable investments."

Three veterans of RTC's liquidation of failed savings and loans during the early 1990s—Rick Williamson, Eileen Lyons and Paul Jones —announced yesterday formation of a $200 million debt and equity fund called WLJ Partners. The primary focus of the fund will be to acquire non-performing or sub-performing commercial real estate whole loanswith an outstanding principal balance between $2 million and $10 million.

The fund could buy larger loans that fit into its investment criteria to add liquidity to lender balance sheets and commercial banks—including "distressed" debt with borrowers still making payments on the loan. WLI Partners view smaller borrowers as more distressed while larger borrowers could still find liquidity from foreign investors.

“We are seeing a lot of product [of commercial mortgage loans] through the conduits, through the special servicers and through advisors—low-loan sale advisors,” Lyons said. “Having said that, they may still be performing but, at some point in time, they are going to meet maturity [and] they won’t be able to refinance.”

Little said economic uncertainties—higher gas and grocery prices impacting nearly 80 percent of consumer spending, as well as “shrinking employment” and changing transportation costs—affect the four food groups of commercial properties. These uncertainties, however, could create opportunity, he added.

“The big question mark for all the above is cap rates. Cap rates compressed dramatically for the spring of 2003 into the summer of 2005 and now into the first quarter of 2008,” Little said. “Today, everyone is wondering about the recoil, particularly in the secondary and tertiary markets.”

“We are entering into another cycle which has features similar to the last three real estate cycles,” Williamson said.

O’Connell said the commercial real estate market is “more intertwined with the capital markets than 20 years ago,” and the current situation is far less dire than during the S&L crisis. “We didn’t come into this period with an oversupply, outside of condominium development," he said. "There is just not a glut of supply.”