CRE Lenders Come Together to Compete
The following is an HTML version of a feature that ran in the January 2013 issue of Real Estate Forum. Click here to view this story in its original format.
At the start of the year Bethesda, MD-based Walker & Dunlop had a nice bit of news for its clients and shareholders: it would be raising its 2013 loan origination guidance to $10 billion to $12 billion, from an earlier guidance of $8 billion to $10 billion.
The decision was not that much of a surprise—the company had posted a 76% year-over-year increase in originations in 2012 following its acquisition of CWCapital.
“We didn’t know where we would end the year and how smoothly the process of integrating CWCapital would go,” says Willy Walker, CEO of Walker & Dunlop. By yearend, he said, it was clear that 2013 would be better than expected.
On one hand, Walker & Dunlop’s announcement is a story of a company pushing hard, and successfully, for growth. It has posted significant movement in the league tables over the past year, not to mention growing originations in the office, retail and hotel categories.
On the other, its projection for increased originations is every commercial real estate company’s story this year.
2013, from all perspectives, will be the year that lending in the sector will truly hit its post-crash stride, with borrowers finding capital to finance growth—as well as refinance old debt.
This was the emerging story line in 2012, but 2013 will unfold with an additional twist, observers say: lenders, especially as they compete for the highest-quality assets, are blurring lines between their traditional products and asset classes to better compete.
“We are seeing a new level of aggressiveness and flexibility among lenders in all categories,” says Philip Mudd, a Washington, DC-based broker with Cassidy Turley.
Commercial banks are offering construction loans with lengthier loan terms. Life companies are offering construction-permanent loans and pushing into equity deals as well. CMBS has become so price competitive that it is targeting the next frontier—more flexible noneconomic terms designed to better compete with life insurance companies. And the agencies? They will fight to retain their market share as other lenders get more aggressive. “The agencies will continue to be significant participants but I do think they will lose some market share to other capital sources that are trying to put money to work,” says Berkadia Commercial Mortgage CEO Hugh Frater, based in Horsham, PA.
In other words, Walker says, it is a good time to be both borrower and lender. “Interest rates and Treasuries are low, the stock market remains high and the CMBS market is coming back,” he says.
Strong Growth for Life Companies
To be sure, the primary narrative for 2013 will be a steady growth in lenders’ primary activities.
“The longer the rates stay low and people feel genuinely comfortable about the economic recovery, the more investors will be willing to buy assets,” Frater says.
He predicts that life insurance companies are likely to do the same or slightly more in commercial real estate lending than they did in 2012. “They have come down quite a bit in yield requirements,” Frater says.
Not that life insurance companies are without challenges. Frater notes that they are not selling a lot of new life insurance policies, which means they are not likely to see much additional growth. “So many of them will just be replenishing their portfolios,” Frater says.
On the other hand, “some life insurance companies are switching to equity allocations from debt allocations, so I believe we will see more in equity lending. Also, some are doing more bridge lending.”
Life will be particularly active this year, says Lawrence Stephenson, senior EVP and regional manager at NorthMarq Capital in Minneapolis. “Life insurance companies are getting more money allocated for real estate and the few life companies that have been out of the market or only did small volumes in 2012 are telling us they will ramp it up this year.”
Certainly that is the case with Prudential Mortgage Capital Co., according to David Durning, senior managing director at the firm. “Last year was overall the second largest year we have had,” he said. “We have a continued low interest rate environment where commercial mortgages are very attractive. At the same time, we see more demand coming from growth in fundamentals. The economy is starting to improve and we are seeing real improvement in the property markets specifically.”
The CMBS Engine
Humming steadily in the background is the CMBS market. Once left for near dead after the crash, the industry posted about $45 billion in transaction volume in 2012. For 2013, estimates put CMBS volumes at $60 billion. Granted, these numbers are nowhere close to what the industry posted in 2004 through 2007. That said, it is clearly on an upward trajectory.
More interestingly, 2012 was the year that CMBS became not only highly price competitive, but also competitive with noneconomic terms.
David Maki, SVP of North American Capital at the Chicago-based Heitman, dates the shift to September of 2012. “CMBS has become, essentially, a highly competitive channel for borrowers looking for low-leverage financing.”
“I think they will give the insurance companies a huge run for their market this year,” Maki says, “and be very competitive on high quality deals this year.”
One attraction for low leverage borrowers, Maki points to, is the level of flexibility CMBS lenders have started offering borrowers on noneconomic terms. Originators realized they had little choice but to move in this direction, Maki adds.
“They know they have a product with a lot of servicing issues.”
In recent months and years, Maki says, CMBS originators have moved to soften transfer language, include high-lease thresholds and strip away as many approvals as possible. In short, he says, CMBS lenders have changed those items and issues that made “borrowers like Heitman and other institutions stay away from the product.”
He adds: “CMBS has tried to create a product that is more like a life product. They have narrowed it to what is needed for the basics of securitization.”
Indeed the life sector is clearly feeling the heat from CMBS, with its competitive price and newly flexible product structure.
In 2012, “we saw CBMS reemerge as strong competitor for loans with portfolio lenders,” Prudential’s Durning says. “Less so from a profit perspective but definitely from an underwriting perspective.”
Northmarq’s Stephenson is also bullish about the prospects for CMBS in 2013. “I wouldn’t be surprised to see originations double in 2013 over 2012.” What happened in 2008, in short, he says, is now a distant memory.
All of this activity is very welcome news, if only because there is a huge wave of debt that will be need to be refinanced this year and next, Stephenson says. And even the most troubled of those properties have hope, he continues—not just from the CMBS community, but from other players as well.
“More and more lenders out there are offering mezzanine and preferred equity in order to prop up properties that might be overleveraged,” he says. “We did a lot more of that kind of business in 2012 than any previous year since the crash, and we believe 2013 will be an even bigger year for mezzanine and preferred equity.”
Whither the Agencies?
If all this sounds like competition for the GSEs, that’s because it is. Multifamily properties are the most coveted of assets lenders want to acquire for their portfolios. The GSEs, though, can count on plenty of businesses even as their competition steps up. Both Fannie Mae and Freddie Mac have been experimenting with their offerings, rolling out such products as floating-rate paper, wrapped securities and shorter-term securitizations. Still, they will focus on their bread-and-butter for 2013—that is, longer-term debt in the ten-year range.
That is just fine with their competitors. Stephenson, for example, doesn’t see agencies increasing their market share. “From our perspective, the agencies have flattened out. They are still doing the majority of multifamily business, but the competition is getting tougher from CMBS and life,” he says.
Where the Products Blur
The red-hot asset class of multifamily is where many lenders are starting to blur their product lines.
Stephenson notes that some companies that own Fannie Mae DUS lenders are also starting to originate loans that they securitize. Durning, as another example, tells of a multifamily bridge financing product Prudential offers that it is now expanding. “We have expanded a program called Agency Gateway Program—it will allow us to have $300 million of appetite in 2013 for transactions in which a borrower is aiming for a Fannie Mae or Freddie Mac permanent loan but for various reasons is not ready.”
The product offers terms of up to four years for multifamily products.
The competitive environment for multifamily bridge financing is a nuanced one, Durning says, like much of the commercial real estate industry these days. “There are banks that are very competitive with their relationships in this space. There are other providers that play more in mezzanine. Prudential, Durning says, fits itself somewhere in between. “That is the space where we think we will have the best opportunity over banks’ low cost of funds.”
The Political Situation
At one time, it seemed the bigger threat to the GSEs was coming from a different direction—namely, Washington DC’s Capitol Hill and the Obama administration. There has been talk from both quarters of privatizing or even dismantling the GSEs.
Multifamily finance facilitators are not worried, though, at least not with this current Congress. Indeed, given the atmosphere on the Hill, Walker of Walker & Dunlop doesn’t foresee any major changes to the GSEs for at least two years. “It will be business as usual for Fannie and Freddie,” he predicts.
But what Washington delivers—in the form of intact GSES—it takes away, in the form of looming market chaos.
Walker is realistically sanguine about these other issues. Walker & Dunlop, for example, hasn’t built into its business plan the possibility that the US hits the debt ceiling and Congress refuses to raise it, but he is relatively certain the company—and even the industry—can ride out such events.
“Here is how I look at it—the US economy is without a doubt the strongest on the face of planet, and we are getting a wonderful hall pass for being the strongest economy.”
“As a result of that we can do we shouldn’t be able to do but are still getting away with doing.” That said, he continues, “at some point international investors will say the game is over. No one knows when that will be.” For the first debt crisis in 2011, Walker notes, theoretically money should have fled the US after its credit was downgraded by Standard & Poor’s.
“But look what ended up happening—investors poured money into Treasuries and Treasuries went down.” As a result, he suggests, there’s now a false sense of security on Capitol Hill that they can do whatever they want and the markets won’t react.
March will be a pivotal month, Walker noted, with expected clashes over sequestration and the government budget and possibly another standoff over the debt ceiling.
The good news is that none of this will be a surprise, Walker said.
“The key thing to remember is that the world economy doesn’t like surprises. Everyone knows what is happening on the Hill and it’s being priced in. There will probably be some choppy moments this year but we are definitely in a better space now compared to 2009.”