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SAN FRANCISCO-David Smith, a locally based vice president of capital markets at mortgage broker Cohen Financial is among many who believe that despite all of the commotion surrounding the capital markets commercial real estate fundamentals continue to remain relatively healthy. He acknowledges they have weakened in almost all property sectors, and that rising vacancy rates, business bankruptcies and spiking unemployment nationally will continue to have a negative impact, but he believes ultimately that the lack of overbuilding relative to the early 1990s will help steady the Bay Area market.

Working with managing directors Paul Schroeder, Robert Kincheloe and Kenneth Fox, Smith is responsible for managing the origination, analysis and placement of debt and equity structures for development, acquisition and permanent financing with banks, finance companies, private equity, etc. Overall, from a lending standpoint, Smith says leverage is down across all asset classes, he says, ranging from 50% to 65% loan-to-value with fixed rates of 6.5% to 7% and 7% to 7.5% for five-year and 10-year deals, respectively. Currently the debt-service coverage ratios are hovering around 1.3:1, higher for riskier deals.

Despite that, Smith says lenders continue to struggle with applying appropriate capitalization rates, especially with the lack of transactions in the marketplace. Uncertainty and caution force lenders to price in a margin of safety, he adds, resulting in an overall decrease of proceeds for even the highest quality of assets.

“We are quickly entering a full-recourse marketplace where quality sponsorship, financial wherewithal and a strong, successful track record are more important than ever,” he says. “Non-recourse money is still available for quality projects with excellent sponsorship, but if you’re considering building your own palm tree-shaped island this year, expect 100% pre-leasing to be a funding requirement. Nothing but the most stabilized of assets will have the ability to attract the limited capital available in the marketplace.”

Smith says Cohen Financial’s debt placement practices in the past several years are benefiting many owners in the coming years. “We were doing 10-year terms with 10-years interest-only,” he says. “That interest-only will be one of the saviors in comings years; it will keep a lot of properties from going under water.”

For every one of those loans there are more troublesome one’s as well, however, because everyone involved couldn’t help thinking the fundamentals would continue to rise indefinitely. “When we were doing a lot of value-add structured finances, people were able to buy on a story; ‘the building may be half vacant but all we have to do is lease it up and five years from now it’s worth double because it’s been stabilized,’” Smith says. “With what had happened and what we were predicting, it all made a lot of sense. We are all guilty of irrational exuberance.”

It remains to be seen what lenders tolerance for risk is at this point. Life insurers are expected to make up the bulk of the lending environment in 2009. If their participation in the first 90 days of the year is any indication, there won’t be much money available.

“A lot of [of life companies] are completely out [of the lending market] and saying while others are saying they are in but not lending and still others are waiting to see what happens in the first 90 days of the year before taking a next step,” he says. “A lot of people are looking at a ton of deals each day but not a lot are making sense, and even with the ones that do it’s getting more and more difficult to convince people it makes sense because they are all expecting things to get worse, whereas a year ago everyone was an optimist.”

Smith isn’t expecting the federal bailouts and stimulus to have any significant direct impact on his business. “Only insofar as it will help bolster the economy because any impact in both consumer confidence and just the overall fiscal impact would help any sort of investment class. But it’s not like we’re going to have $50 million got to KYZ bank and get to start lending that money.”

For the commercial real estate market to find solid footing, he says the residential foreclosures need to stop. So a big concern for everyone, he says, should be what will happen to the economy six months from now when borrowers begin defaulting in earnest on their “alt-A” loans, that huge market between subprime loans and prime loans, where many highly educated dual-income couples in expensive markets like San Francisco founds themselves when buying a house over the past several years.

What happens now that one of them has lost their job and the interest rate on that unused credit card they had planned to use to cover the difference has been jacked up to 29% from 4%, Smith asks, rhetorically. “It’s the perfect storm,” he says. “Somebody has to take the loss.”

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