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Michelle Napoli is editor of Net Lease forum, from which this article is excerpted.

Pittsburgh—There are few certanties about the current debt markets for commercial real estate, other than the reality that the environment is in flux and predictions are hard to make. While some market observers expected this fall to be a repeat of 1998–when a halt in the CMBS market created a void that life company lenders readily filled–it hasn’t quite worked out that way, at least not yet or to the extent some were expecting.

Life lenders are stepping up “to a certain extent,” says Nicholas P. Matt, a managing director in the Pittsburgh office of Holliday Fenoglio Fowler LP, but “they haven’t really filled the gap as much I would have liked.”

Matt says two issues are holding them back. “Like CMBS lenders, they’ve had a good run,” he explains. As a result, for many, allocations to commercial property lending have already been filled or are so close to being filled that they can afford to cherry pick deals for the remainder of the year, short of getting increased allocations. The second issue is that the same investors are also big buyers of CMBS AAA paper. And with yield paramount and a lot of paper backed up in the system, they are able to buy AAA slices at 130, 140-basis-point pricing. “That’s just a lot better than doing loans at 150, 160 on so-so property,” Matt observes.

For single-tenant properties, market sources agree debt is now harder to come by–except for very strong, investment-grade credits. Underwriting standards have tightened considerably and are now more reflective of historical life company/CTL underwriting, and CTL-type lending is now looking more competitive relative to 10-year conduit financing after a long stretch of not being able to compete, says Tom Bell, Des Moines-based investment director of Principal Real Estate Investors.

In addition to renewed focus on credit, lenders are paying more attention to other basics, including greater scrutiny to primary markets versus secondary and tertiary markets. “People are starting to differentiate on location more. There is more focus on basic real estate fundamentals, which I would think bodes well for the future,” says Bell. “We’re underwriting more closely.”

Overall, says Bell, “it looks like competition has come back into the market more than some would like,” with absolute spreads for conduit loans declining about 20 basis points last week. “The conduits are still active,” he continues, noting that Principal’s CMBS operation has produced roughly a half-billion dollars since the debt market lock-up started in July. But for single-tenant properties, because of the power of B-piece buyers, “there’s somewhat of an aversion to single-tenant product in the conduits right now,” Bell adds. “It means a little more discipline.”

Commercial banks dominate the commercial/multifamily property lending market, with 43% of outstanding debt, according to a recent report from Boston-based Torto Wheaton Research. But the CMBS market has been gaining share in recent years, and CMBS issuers now account for 22% of outstanding debt, while life insurance companies account for just 9%. “The capitalization level of the US securitized commercial real estate debt market currently stands at $650 billion,” the report notes. “With 2007 issuance level projected at more than $200 billion (compared to $40-$45 billion for insurance companies), the securitization market now sets the benchmark for fixed-rate mortgages.”

Of course, the fourth quarter has just started, so the debt markets and its key participants could very well continue to shift and adapt to changing conditions. But some adjustments appear to be certain: as John B. Levy, president of Richmond, VA-based real estate investment banking firm John B. Levy & Co., says, “it’s the end of free money” and “risk has really been re-priced.”

Heading into the year’s last few months, Bell says he expects the market and the broader economic environment to be steady, with some dark clouds but not so ominous to cause him alarm. “Nothing real positive and nothing real negative,” is how he puts it.

“I think in the next few months, the life companies are going to take a hard look at the economy in general, and consider how much they want to be in real estate,” says Holliday Fenoglio’s Matt. “There are definitely some dark clouds for the general economy itself.”

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