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February 22, 2001

NW lenders keep the green light on

  • Despite ongoing news reports of an impending recession, most lenders are eager to lend as much or more than they did in the previous few years, though some are receiving hints that their green lights should take on shades of yellow.
    • By ROBERTA FUHR
    Key Bank

    What can one expect this year in the Puget Sound commercial real estate financing arena?

    The answer is: plenty. There’s funding available, along with a strong willingness to lend from sources such as banks, thrifts, credit companies, conduits, life companies and Wall Street.

    This marketplace offers many choices for financing equity, construction and long-term permanent loans. Despite ongoing news reports of an impending recession, most lenders are eager to lend as much or more than in the previous few years. The Puget Sound commercial real estate market has enjoyed a long period (really since 1994) of rising rents, decreasing vacancies — especially office and apartments — relatively stable, long-term interest rates and strong employment growth. Local and out-of-state financial service providers have become accustomed to financing large projects with substantial loans and continue to view the Puget Sound market as an area of opportunity.

    To prepare for a recent presentation, I interviewed senior executives from a number of Northwest financial service providers. With an initial focus on construction and interim lending, I inquired about their new loan origination volume goals for 2001; their organization’s range of real estate loan products; their opinion on favored/unfavorable property types; and whether they expected to tighten their credit/underwriting standards.

    The results surprised me, especially the anticipated volume figure, particularly since I spoke with only eight financial institutions. Collectively, the 2001 volume estimates for KeyBank, US Bank, Bank of America, Washington Mutual, Fremont Invstmt, and BancOne totaled more than $1.6 billion (two institutions asked not to be identified). Only one institution interviewed had a 2001 volume estimate that was lower than their previous year’s.

    Most provide 24-to-36-month construction and interim (bridge) loans. These are non-owner-occupied (i.e. tenant-occupied) loans to developers. Other than Washington Mutual, which prefers the $1 million to $10 million-loan size, the other institutions indicated they have the ability and capacity to provide larger project loans. Most, in fact, have loan syndication capabilities. They sell off anything above their “hold limit” which is typically in the $25 million to $35 million range. The volumes shown above represent “net hold positions” or net of syndication sales.

    Favored property types, ranked by appeal, continue to be apartments, industrial, retail and office (a distant fourth). Weak-tenanted office (defined as an office building with tenants who have no profit history) was off the chart, off the bottom, that is, in a category that includes hotels, healthcare/assisted living, and single-tenant retail.

    When questioned about anticipated changes in credit underwriting, the institutions’ overwhelming response was to “proceed with caution.” Although most of the lenders declined to say for the record that they would absolutely make changes, it is apparent that there will be heightened scrutiny of borrower equity, rent pro formas, tenant quality and exit strategies. Most indicated they would tighten repayment recourse requirements. There is growing interest in requiring interest-rate hedges to mitigate risk in the event of long-term interest rate increases.

    Subsequent questions focused on permanent loans for tenant-occupied commercial properties. Permanent loans typically have 10-year terms (or longer), and are non-recourse to the borrower (i.e. they do not require repayment guarantees). I broadened my survey base to include mortgage bankers and asked similar questions about volumes, favored property types and underwriting outlook. Again, the overwhelming responses were optimistic regarding the Puget Sound region.

    Although specific volume estimates were unavailable, interviewees assured me that demand from life insurance companies, conduits and Wall Street funds was very strong, and would continue to be so through the rest of this year. Most of the banks do not offer permanent loans, except through their conduits.

    According to local mortgage bankers, the life insurance companies favor financing apartment, industrial and retail properties. Office, however, is not currently favored by life companies because the large volume of office refinances completed over the past two years has created property-type concentration issues. Conduits, on the other hand, look favorably on office, apartments, industrial, retail and mini-storage. Single-tenant retail is a difficult property for conduit financing. Any kind of weak-tenanted property is out of favor with most lenders.

    FNMA and Freddie Mac are popular permanent financing alternatives for apartments and compete very favorably with life company and conduit loans. These lenders may grant borrowers additional fundings throughout the loan term as rents and property values increase.

    The last component of my interview focused on equity and mezzanine financing. There are some interesting mezzanine programs in our market, depending on a borrower’s need. Permanent-loan mezzanine, offered by conduits and some mortgage bankers, provides funds to bridge a shortfall on first mortgage loan dollars. Typically, these loans have a two-to-three-year term and are secured with partnership interests. Repayment comes from the property’s excess cash flow.

    Construction equity and mezzanine programs are offered by banks with capital markets groups, credit companies and Wall Street funds. These programs vary, but they typically provide 95 percent to 100 percent of the equity needed in a project and require the developer to pay a preferred return and share of the profits. The equity provider will be looking for an internal rate of return on investment in the high teens-to-mid 20s. Again, favored property types in this area are apartments, followed by industrial, retail and office. Due to the short-term focus, this type of third-party equity/mezzanine is typically used by merchant builders who plan to sell the property after construction and stabilization.

    Today, the possibility of a local or national economic slowdown is not noticeably compromising debt availability for short-term construction loans or long-term permanent loans. This is only the first quarter, though, and lenders are receiving hints that their “green lights” should take on shades of yellow. Much of the talk about caution, though, is being overshadowed by a desire to generate loan volumes equal to, or greater than, last year’s. The state of the economy will dictate whether these volumes are realized.

    Roberta Fuhr is senior vice president and western regional manager for Key Bank Commercial Real Estate.


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