REBusiness Online recently spoke with Ryan Chapman, vice president of Johnson Capital in Irvine, Calif., about the current state of the commercial lending market. Johnson discussed the rise of multifamily assets, the narrowing bid-ask gap and the lending sweet spot.
REBusiness Online: How do you see the commercial lending/financial market in 2010?
Ryan Chapman: It certainly does seem as though someone hit the switch after the first of the year. People are tired of banging their head against the wall and are eager to get back to work. A few recent single-borrower securitizations were well received in the marketplace. Some conduit lenders are announcing that they are dipping their toes back into the market to originate loans designed for multi-borrower securitizations. The agencies continue to provide liquidity to the multifamily space, and just recently, Congress reconfirmed its support.
In the existing portfolio of commercial real estate across California and throughout the country, we have essentially three types of existing transactions. There are those that work. These properties are cash flowing, have little expectation of erosion of the existing cash flow and are appropriately leveraged given the property’s current value. These properties will refinance or can be sold on the open market at returns expected by core investors. The subset of properties that do not work are significantly overleveraged and are not cash flowing. The value of these properties will need to be reset, either through recapitalization or sale. There are plenty of investors out there anxious to get their hands on these properties, given the right ask-bid [pairing]. Lastly, there are properties in the in between stage. They may be overleveraged but cash flowing or near break-even on leverage or cash flow.
From the economy’s perspective, we are firm believers in job growth being the single most important factor in determining recovery and growth. When companies start hiring, office buildings fill up, people have money to spend, both on retail items and on housing, retailers make leasing decisions and order more inventory, manufacturers turn on their machinery and bring back laid-off workers, industrial buildings get leased and stay filled with goods that are being moved through the nation’s distribution network, and so on.
REBO: How are the credit markets?
Chapman: Traditional, non-securitized capital has returned, but at lending parameters that reflect the current risk profile of the marketplace. For debt, the downside is unlimited, but the upside is capped, so as the economy recovers, conditions will improve, but at the margins. Eventually, additional capital comes into the market to provide balance in supply and demand.
REBO: Is there a sweet spot where you feel comfortable lending in today’s environment? What criteria must deals hold today to garner your attention?
Chapman: Without question, the quality of the asset, the location, and the borrower are king. As a Freddie Mac seller/servicer and an FHA MAP lender, we are looking for borrowers with track records in the ownership and development of multifamily properties and whose expectations are based on real and sustainable cash flows, taking into account any adjustments between in-place rents and the true market rents.
For other commercial properties, in addition to sustainable cash flows, be it a refinance or acquisition, transactions will require real borrower equity. Sure, leverage is there, but 60 percent is the new 70 percent, and, with few exceptions, forget about obtaining mezzanine to take you beyond 80 percent.
REBO: Do you find in this market that you are focusing more locally, regionally or nationally?
Chapman: We have offices located around the country and, as such, are marketing nationwide. Certainly, some markets became so overheated in the run up between 2003 and 2007, and properties were so highly levered that straight refinancing of those transactions is more difficult to get done. However, at the same time, that is where all this new capital coming to the market will have a place. Just as the bid-ask gap narrows in sale transactions, borrowers and lenders are coming to grips with the cost of capital required to recapitalize transactions.
REBO: What commercial property type should stand out the most during 2010 and why?
Chapman: Congress’ support of Fannie and Freddie will assure that through 2010 multifamily will remain the most financeable product type. That being said, distressed transactions across all product types that do end up making it to market, and trade at either significant discounts to the value of the existing note or in comparison to what the property was valued at or traded for in the last few years, will attract headline attention.
REBO: What's the biggest concern you’re hearing now from commercial developer and investor clients?
Chapman: Where are the tenants? Developers and investors are most concerned with their bottom lines, and that is driven by tenants who are growing and/or expanding their businesses and are looking to occupy space. As the economy improves, tenant activity will return, and this supports further development and investment activities.
REBO: What’s the biggest financial trend you’re seeing in distressed real estate?
Chapman: I think a lot of 2010 will be wait and wait some more when it comes to distress. It is becoming clear that it will be a trickle, not a flood, at least through 2010. Whenever possible, lenders will work with their good borrowers to find a mutually beneficial solution to maturity defaults that are having difficulty finding a new home.