Wally Harding
Depending on who you talk with, the troubled commercial real estate situation is continuing its downward spiral, approaching the bottom or has bottomed out and will begin recovery late this year. A look at today’s market paints a picture of either a sunny ray of hope or continued grey clouds of financial woe and despair.
The problem is not money. There are more than ample funds sitting on the investment sideline. This money has been there for months, and new investment funds are being created by numerous groups that hope to take advantage of someone else’s problem assets. Loan money is also piled high in the vaults of life insurance companies, banks, credit unions and investment banking groups. By virtue of the amount of money waiting to be utilized and the number of new funds being organized, it’s safe to say the bottom may be near.
Should it be invested now? In 6 months? In late 2010? The problem lies with lending collateral (product), conservative underwriting, lack of sales (comparable data for appraisers and valuations), falling rental rates, lack of borrower liquidity and over-leveraged existing loans with near-term note repayment dates. Adding capital ratios to the picture, you find that portfolio valuations are suspect, loans are over-leveraged and ratios are stressed to questionable levels.
It’s no wonder that lenders to this industry are confused. Is it surprising they have “pulled in their horns” when it comes to lending money? Is it surprising that they ask for more and more information from borrowers, appraisers and mortgage bankers before parting with their money? All of this is a sign of the times. Borrowers need to recognize the new rules rather than continue to implement lending standards from 2005.
Many experts in the industry see no turnaround for as much as 24 to 30 months. The market for loans, new and old, has unraveled, and sale and lending transactions have come to a virtual standstill. There is no industry benchmark for property valuation or loan underwriting. Commercial mortgage-backed securities defaults continue to increase. This one area is the most troublesome, since it is of significant dollar size, affects a significant number of individuals, companies and investors and has a duration period for stress for 4 to 5 years.
There is a ray of hope. Money is coming into the system from most of the traditional sources. Construction loans are being extended whenever possible. We will continue to see well-conceived properties qualify for both term and construction projects. The lending attitude is one of caution, however. Loans will be made following prudent underwriting standards. More equity will be required, but these additional dollars will be contributed through direct equity, joint ventures and secondary/mezzanine debt.
It will take time to get through this problem. We will see the so-called bottom when we see transactions start to occur for performing assets. Should this occur next year, we will see emerging confidence in the market. This new confidence will send a signal to the investment community that it is time to create profits, not shore up the balance sheet.
Have we hit bottom? Many industry experts don’t believe we have. But a return of investment and lending funds has begun, and, with a little luck, the trickle of dollars will turn into a full stream of completed deals. We should see this occur sooner rather than later.
— Wally Harding is a senior vice president in NBS Financial Services’ Portland, Ore., office.