Have Commercial Loans Dried Up?

Have Commercial Loans Dried Up? DETROIT, MI - Conduit lending, non-recourse loans, life insurance companies, major banks - several structures and sources of credit once readily available for commercial real estate have dried up almost completely. How long it will take for the capital markets to recover is the question of the day, but real estate leaders are also acknowledging that what emerges will look very different from the activities of the past 10 years or so.

That leaves the commercial real estate community in Michigan - where the weakening national economic dynamics are compounded by the auto industry's struggles - bracing for a new, undefined way of doing business.

Albert Berriz, CEO of McKinley, the Ann Arbor based real estate company with commercial and residential holdings in 15 states in the Midwest and Southeast, said it could take a generation or more for commercial lending to resemble what it once did.

"Several decades," was Berriz's response when asked when a capital market recovery would happen.

"Because the number of people who had bad experiences won't forget those quickly," he said. "So the way that we've been borrowing money in the last 10 years in commercial real estate will profoundly change in the decades to come."

Berriz singled out non-recourse loans as a structure that is not coming back, and said that the level of leverage will also shrink.

"There will be less deals. Values will be less. But you're going to go back to the basics," he said.

Overcapacity in office and retail will also work to constrain future activity, said Berriz. That idea was echoed by Aaron Klein, owner of Commercial Mortgage Capital in Ann Arbor.

"Capacity definitely is enormous," he said. "We're going to have a contraction in consumer spending, and that's going to stay with us for a while. We're definitely overbuilt."

Klein also said life insurance companies are less willing to finance deals than in the past. "Life companies are experiencing the same challenges with their financing that everyone else is," he said.

The restricted capital markets and the financing environment that might emerge were the subject of a panel discussion at the Synergy commercial real estate conference in Lansing last month, where participants agreed that a new model is here.

Panelist Patrick Fehring, president and CEO of Level One Bank in Farmington Hills, held out hope that the nation's larger banks will come back to the commercial lending market if their earnings hold up over the next two or three quarters.

He said once banks are able to turn their attention from protecting their earnings to expanding them, "you'll see banks enter the market more aggressively."

He said a key indicator will be simply the core earnings of the big banks over the next few quarters. "We're just at the bottom end of a cycle," Fehring said. "It'll take five or six years to be close to where we were before."

Panelist Scott McKelvey, executive vice president at Monroe Bank & Trust, said previous lending practices, including the relatively high loan-to-value ratios of past years, will not return any time soon. "Going forward, banks are not going to go back to the old relaxed ways of lending," he said.

Relationships rather than transactions will drive commercial lending going forward, added Jeffrey Schuman senior vice president and senior client manager at Bank of America.

"Our focus today is in allocating the limited amount of real estate capital we have," he said at Synergy. "The first call goes to existing, established clients ... if we have a customer with a substantial deposit relationship, we'll do things for that client we wouldn't do for others."

Panel moderator Dennis Bernard of Bernard Financial Group in Southfield, also brought up the potentially sticky issue of how lenders will treat borrowers in the future who are forced to go through loan workouts in the current environment.

"It's a tough question, no doubt," Fehring said. "The key is how the workout goes. The style of the workout will impact the borrower in future years."

"If customers are honest and truthful with us, we'll try to work with them again down the line," said McKelvey.

In the meantime, multifamily transactions through government agencies and smaller deals are the easiest to complete, Klein said.

"All of the deals getting done are very moderately leveraged, with substantial cash equity in the deal, with conservative amortization schedules and generally a full recourse guarantee from the owners," he said. "We are still funding deals, but lenders have their pick and are picking the ones that have the lowest roll-over risk in terms of tenants, the strongest sponsorship and the best submarkets."

In Michigan, that latter point means Ann Arbor and Grand Rapids, Klein said, which have relatively diverse economic bases.

Deals of less than $10 million are easier to fund also, he said, because it allows for lenders to diversify their risk in many smaller transactions.

"Multi-family housing is the primary product that's financeable because we still have government agencies that are active," he added.

For the other commercial deals getting done, he has a large group of out-of-state lenders, including individuals, pensions funds, and life insurance agencies, as prospective lenders.

"It's a very capital constrained environment," Klein said. "The available capital with respect to commercial real estate is a fraction of what it was 18 months ago."

Berriz said the days of seemingly endless increases in commercial real estate values, which enabled some of the poor lending practices, but are probably gone for a long, long time. "We've gone through a period of hyperinflation in values and it was just unconscionable," he said.
Source: mLive.com

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