If there’s one statement appropriate to describe the current lending environment, it’s “The worst is yet to come.” Now that phase one of the residential debacle is behind us and phase two is just beginning (more than 1 million foreclosure notices of default are generated every 12 weeks in the United States), commercial real estate is about to go through one of the worst eras it has experienced in a long time.
While delinquencies and vacancies continue to rise, we have yet to really see the catastrophe being created by tighter underwriting requirements, stricter credit, bank failures and consolidation, and current and future loan losses in our nation’s banks and commercial mortgage-backed securities (CMBS) market.
According to Fitch Ratings, there were approximately $50 billion in delinquent CMBS loans as of July 31, and that number will probably reach $100 billion by year’s end. CMBS delinquency rates are expected to eclipse 5 percent by the end of 2009. There’s an incredible amount of maturing CMBS and portfolio debt, and nowhere to refinance these if not a well-performing and reasonably leveraged property.
In a recent survey of 120 company presidents, CEOs and other executives, 82 percent indicated real estate values would remain flat or decline in the next 12 months. Moody’s/REAL Commercial Property Price Index said $2.2 trillion of properties acquired or refinanced in early 2004 lost value since the transaction, and many of these properties―typically leveraged 70 percent to 80 percent―will face significant refinancing hurdles, even if prices hold firm.
Few lenders today are willing to advance more than 50 percent to 60 percent of value. “The bottom line: Defaults are exploding,” says Richard Parkus, an analyst with Deutsche Bank. “It's terrible. It's going to be worse than in the early ’90s.” Parkus expects the market won't begin to turn around until 2012 at the earliest. By then, commercial-property prices will have declined by as much as 50 percent from the peak in early 2007, he estimates.
Available credit―and certainly cheap credit―will go to properties with low loan-to-value (LTV) ratios and strong borrower balance sheets, or to borrowers with the ability to provide additional collateral. If you’re looking for a takeout or construction loan with a property still in leaseup, finding a lender other than your current one will be near impossible.
While the government is trying to pump capital into the banks to induce lending, much of the funds have gone to allow select banks to buy failing banks, relieving the FDIC of the need to take over and manage them. As of August, the bank-failure tally was more than 80, with many more on the horizon.
The capital infusion has also gone to strengthen bank reserves, needed to cover mounting loan losses as well as under performing or over leveraged loans. Many major money-center banks, such as Citibank, are out of the commercial-lending market and are instead concentrating on a growing portfolio of special assets. Others, such as Chase, are looking for loans at 60 percent LTV or less and restricting asset types. Because of this, the availability of credit is fast becoming a crisis.
The good news is if you have a maturing loan, your current bank or CMBS servicer may have no option but to extend it, although likely at a rate, term and amortization less than what you’d like to see. If you have a conduit loan maturing, it may be more complicated, dealing with special servicers and the real estate mortgage investment conduit that holds the loan pool.
Much of what is happening today was forecasted earlier in the year, but the problem is much worse than anyone expected. Businesses large and small are closing, causing vacancies in all commercial property types. People are losing their jobs or concerned about losing their jobs, spending only on necessary living expenses. This reduces store sales and causes slower tenant payments, broken leases and re-negotiation of rent.
The pressure is on the property owner to keep the cash flowing, and on the lender to keep the loan afloat. Mounting loan losses are restricting lenders’ ability to originate new loans, as capital must be retained to stay solvent. Rumor is the FDIC is planning to close more than 100 banks this year, but the number of banks on the watch list is much higher.
What You Should Do
Banks are still your best bet, but expect LTVs to max out around 60 percent to 65 percent and, on occasion, 70 percent. If you owe more than that, you may be required to pay the principal down, provide additional collateral or, if you’re lucky, have your existing lender refinance you at terms that hopefully make sense for both parties. Most banks are opting to keep fixed rates at three- to five-year terms or go with a straight adjustable rate. Amortizations range from 15 to 25 years or, sometimes, 30 years.
Rates in the mid to high 6 percent range should be expected at minimum and can exceed 7 percent with ease. Insurance companies and pension funds are also good funding sources, but they will cherry-pick the best properties with lower LTVs, good histories and strong locations. Expect 10-year fixed rates to be in the 7.25 percent to 7.5 percent range, and amortization to range from 20 to 25 years.
Start looking to refinance at least 6 to 12 months prior to maturity. Begin discussions with your current lender early to find out if it even will be able to entertain an extension. One of the biggest financing changes is the inability of mortgage brokers and bankers to fund loans nationwide, as many of those sources have either dried up or gone away, leaving a few national and regional banks and handful of insurance companies to provide the funds required.
Have your financial house in order and your property financials up-to-date for the best results in your financing search. Now more than ever, a mortgage professional may be the key to helping you obtain a loan—whether it’s the perfect one or not. These days, you may need to take what you can get.
David Smyle is the president of La Mesa, Calif.-based Benchmark Financial, a commercial mortgage banker providing financing options for self-storage and other commercial property types nationwide. For more information, call 877.862.7916; visit www.benchmarkfin.com.