As we close out a difficult 2009 for the commercial mortgage industry and begin focusing on trends for 2010, MortgageOrb checked in with Adam Luysterborghs, managing principal at commercial mortgage banking firm Avant Capital Partners. Luysterborghs offers his assessment of the current market, weighs in on the federal government's relief efforts and gives us his predictions for next year.
Q: In general, what are your current financing parameters for closed deals (maximum loan-to-value (LTV), average interest rate, special deal features)? How have they changed over the course of this year?
Adam Luysterborghs: This varies according to asset type, property location, borrower profile and debt structure requirements. Loans for stabilized multifamily properties in strong markets can achieve up to 80% loan-to-value with a minimum required debt-service coverage ratio (DSCR) of 1.25x on a 30-year amortization schedule, at an interest rate below 6.00%.
Properties in weaker markets are limited to 70% to 75% LTV, and may have higher minimum DSCR requirements. Bridge loans for in-transition properties have ranged from 65% to 75% loan-to-cost, with interest rates as low as 5.25%. These bridge loans are structured with interest-only payments during the renovation period and are often convertible to a mini-perm on a 20-year or 25-year amortization schedule.
Closings have occurred in 30 days or less for bridge loans, compared to a minimum of 45-60 days for permanent agency loans. Loans closed on other commercial property types have ranged from 60% to 75% LTV at a minimum 1.25x DSCR, with terms up to 10 years and rates between 6.00% and 7.00%.
We have not seen loan parameters change dramatically over the course of 2009. This is not surprising considering the sea change that had already occurred in 2008 that essentially reset underwriting standards and deal structure for debt.
Where we have seen significant changes, however, is in underwriting requirements and due diligence. There is an increasing scrutiny of borrower liquidity, global cashflow and contingent liabilities. Underwriters are no longer relying solely on in-place property cash flow and borrower net worth when assessing credit risk. They are conducting a thorough evaluation of the entire financial picture to identify any existing or potential future risk.
Banks that are still actively lending find themselves so inundated with requests that loan officers have little time to work with borrowers to get a file in shape for an approval. This new landscape has increased the importance of experienced intermediaries, and other trusted financial professionals, to provide the financing structure and advisory services required to get the deal done in today's credit environment.
Q: What are your preferred asset types right now? Which are not currently in favor?
Luysterborghs: Assets such as student housing, assisted-living or seniors housing, and medical offices are niche property types that have shown stability and continued demand during the economic downturn. The specialized use and additional development and management complexities have kept these asset-types from being overbuilt during the recent construction boom.
These assets are ideal for qualified developers or investors that are seeking stable long-term holds, and are still looked upon favorably by conventional and institutional lenders who understand the niche product.
Investors seeking higher-yielding value-add opportunities are focusing on multifamily assets that can be purchased cheaply. We are seeing all-cash buyers able to successfully operate in the current climate. The collapse of the commercial mortgage-backed securities (CMBS) market and subsequent loan defaults have created instances where distressed assets can be purchased at a discount, often below replacement cost.
Many of these distressed properties are decent assets located in strong markets that fell victim to mismanagement and/or over-leverage.
As new construction activity slows, experienced owner/operators are finding opportunities to acquire these undervalued but non-performing assets for a fraction of their original cost and repositioning them in the market. Upon completing any required renovation and achieving stabilized occupancy, these properties can be refinanced or sold. To execute this business plan, sponsorship experience and financial strength are key factors of success.Â
Out-of-favor asset types include retail and hospitality. Hospitality has historically been a risky asset type, due to the sensitivity of room demand to seasonal and cyclical fluctuations. When the economy suffers, business and leisure travel immediately experience weakening demand. This industry will continue to suffer due to overbuilding in recent years until an economic rebound is in full swing.
As national retailers struggle and small businesses fail, retail properties are seeing high vacancy rates and falling rents. We are seeing retail tenants demand rent concession and moratoriums under threat of closing their doors. Landlords are forced to choose between these concessions and looming vacancies that could make their ideally bustling centers look like more ghost towns (affecting every other tenant in the center).
Like hospitality, this sector is tied to how well the economy performs. Softer spending by consumers in a weak economy directly impacts retail sales, leading to store closings. Large tenants going dark often impact in-line tenants, who rely on them for increased traffic.
Q: How significant do you think the recent news of new CMBS issuances is, given that the market had been dormant for so long? Does it point to recovery yet?
Luysterborghs: The news is huge. The downfall of securitization, and widening spreads on legacy issuance, signified the end of the commercial real estate bull marketplace. Many of the funds invested in securitized residential mortgage pools where also CMBS investors. As spreads widened, they saw huge losses on their existing investments.
The tightening of spreads since the spring of 2009 was a necessary prerequisite for those, and new, investors to enter the newly revived securitization market.
As securitization re-establishes itself as a reliable source of liquidity for commercial real estate lenders, we are going to see the pace of dispositions and recapitalizations accelerate because senior debt for large and mid-size projects will be more abundant. All of this is healthy for the commercial/multifamily debt markets. Let the healing begin.
Q: What effect have the Troubled Asset Relief Program (TARP), the Term Asset-Backed Securities Lending Facility, etc. had on the commercial mortgage market? How might the government better help the industry, if at all?
Luysterborghs: Most economists and market participants believe the financial system has stabilized and that TARP helped restore necessary confidence. So the theory goes, this renewed confidence has/will enable the economy to recover from one of the most serious recessions in U.S. history.Â
However, if we are looking for dramatic improvements in liquidity, especially when it comes to commercial real estate, it is hard to be enthusiastic about the results. Even though the money center banks are considered well capitalized and spreads have tightened considerably since the spring of 2009, it is as hard to get financing on commercial properties today as it was before TARP.
There still exist many well-capitalized banks that never needed TARP and do not have to fudge asset values on their balance sheets to be judged solvent. Many of these banks are run by experienced local and regional real estate operators who, as their local empires grew, built out new banks.
These bank presidents are experienced capital decision makers with money to lend, so why are they on the sidelines? They know a good deal when they see it but are mainly frozen into inaction out of fear of their regulators. The cost of being sanctioned outweighs the possible benefits of lending.
The market needs these real estate banks to finance in-transition assets that make sense, but they will often sit on their hands rather than draw the ire of their friendly neighborhood regulator.
Suggestion to regulators: Take a step back from the well-capitalized banks that didn't fail. It's their competency and capital that will carry the market through this downturn and enable the poorly run banks to dispose of broken deals and underwater assets.
If banks cannot participate in the recapitalization of broken projects, those projects are more likely to remain broken for longer and remain on the balance sheet of the losers.
Q: Finally, what are the top three trends to look for in commercial real estate financing for 2010?
Luysterborghs: I believe that 2010 will show a gradual move towards recovery, as the industry absorbs the lessons learned in 2009 and sellers and buyers adjust to the new reality.
On the lending side, we will continue to see bank failures work their way through the system. However, capital will free up as the survivors clean up their balance sheets and adopt more conservative, common-sense underwriting standards.
If regulators allow it to happen, these market players will facilitate a cleansing of the system characterized by bad banks selling bad assets to new sponsors at valuations that make sense. Transaction volume will increase as more properties move out of the foreclosure and bankruptcy processes and into the marketplace for disposition.
We expect to see the old way of doing business, based upon personal relationships and advice, increase in popularity to become the norm. The fax machine dealmaking and fast talk that was so prominent during the boom years will wither away and die. Occupancy and rents will not immediately recover, but values should stabilize as the worst of the storm is behind us.
Overall, 2010 is going to be a great year.