The WPJ

Realty Capital Markets Stay on Slippery Slope, RECI Reports

Commercial News » Commercial Real Estate Edition | By Alex Finkelstein | April 6, 2010 11:10 AM ET



Chicago-based Real Estate Capital Institute reports realty capital markets continue on "a slippery path of gradual recovery held up by the Fed's desire to keep benchmark rates unchanged - a policy upheld since December, 2008."

At the same time, notes RECI Research Director Nat Zvislo, investors are nervous and driving up spreads as fed notes and bonds start to saturate debt markets and ultimately trending towards higher rates.

In the past month, treasury notes rate ranges climbed by 25 to 40 basis points, with shorter-term maturities showing the most movement.

Ultimately, this trend leads to higher borrowing costs, but pressure to invest is driving down spreads over treasuries, Zvislo reports.

Bank cost-of-funds are still at record-low levels, but legacy deals and loan workouts take front stage. "Therefore, new construction and higher-leverage funding are still  problematic for short-term fundings," according to RECI.

As for longer-term permanent loans, life companies, select CMBS lenders and pension funds are selectively returning to the realty capital markets, but in incremental steps.

Agency lenders remain firmly committed to multifamily lending about 85% market share.

Loan underwriting "tweaks" are now the norm as these lenders want to differentiate themselves in capturing funding opportunities from a limited pool of qualified projects.

Tweaks include:

  • Typical bank deals are structured with very attractive spreads over LIBOR (e.g., 350 bps).  However, floors are formulated on the base calculation (LIBOR floor of 1.5%), effectively raising the rate to a base of 5%, for instance.  These floors are starting to be lowered as banks compete more.
  • Mezzanine loans are now bundled with agency debt with leverage in excess of 80% becoming commonplace for higher-quality multifamily loans.
  • Loans that are 100% or more above value are known as "pretend and extend" situations where lenders are losing hope of full principal recovery. If more equity is contributed, bringing the leverage levels to 80 to 100%, financial institutions will usually cooperate with loan modification actions.
  • Full leverage of as much as 75% of value is offered at premiums of 50 basis points or more in rate.  While the premium is still costly, this tweak signals lenders' willingness to raise the leverage bar based on current values.

Real Estate Capital Institute's Advisory Board member, Gary Duff, who also is an Executive Director with Morgan Stanley's Fixed Income Group in Los Angeles, notes "In a sign of renewed optimism, Wall Street re-enters the markets in its more traditional role of funding large and highly structured transactions, as well as ventures with debt/equity components."

Duff suggests "Normalcy is returning at levels comparable to the late 1990's."




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