Fueled by a low interest rate environment and strong investor demand, NorthMarq Capital expects to arrange between $8 billion and $9 billion in commercial real estate financing in 2011, an increase of at least 50 percent from a year earlier.
The Bloomington, Minn.-based company arranged approximately $5.2 billion in commercial real estate financing in 2010, according to CEO Edward Padilla, who describes this year’s huge surge as a shocking surprise.
“Going back a year, there were some economists talking about a 10-year Treasury yield of about 5 percent, or certainly above 4 percent,” says Padilla. Today, however, the 10-year yield is hovering around 2 percent, near an all-time low. That’s significant because the 10-year yield is a benchmark for long-term financing in commercial real estate.
The multifamily sector is a big reason for the boost in volume. When all is said and done, NorthMarq expects to arrange $2.5 billion in multifamily loans through its seller-servicer relationship with Freddie Mac this year, easily beating the company’s previous annual high of $1.5 billion. That’s before factoring its loan origination business through Fannie Mae into the equation. Collectively, Freddie Mac and Fannie Mae will account for $3.3 billion in multifamily financing for all of 2011, says Padilla.
Real Estate Business Online talked with Padilla about the boost in lending activity this year and what product type is hot and what’s not with lenders.
REBO: How much of the increase in lending volume was driven by new development versus acquisitions or refinancing?
Padilla: Very little of our production involves new development. New development probably makes up 5 percent to 10 percent of our production. Acquisitions account for 25 percent to 30 percent. And the remaining 50 percent to 60 percent is pure refinancing.
The new development we’ve been involved with is almost exclusively multifamily, or something that does not have a leasing risk associated with it such as a build-to-suit or a substantially pre-leased project.
REBO: Why is the lending community so bullish on the apartment sector?
Padilla: It’s clear that apartments as an asset class have incredibly low vacancy rates with among the highest actual rent increases. Their general performance is exceptional. The only way you are not doing well as an apartment owner now is if the property is a B-class asset in a few of the worst markets in the country, or if you are overleveraged.
REBO: The multifamily CMBS delinquency rate for loans 30 days or more past due is approximately 16 percent, according to New York-based Trepp LLC. If the multifamily sector is performing so well, why is the delinquency rate so high?
Padilla: The majority of the way CMBS [loan originators] managed to win multifamily transactions was either through large structured deals, or by simply pushing the leverage level higher than anybody else, especially during the 2005-2007 time period. The structured-type financing included multiple layers of debt involving large, large transactions.
REBO: What’s the next most popular sector to finance after multifamily?
Padilla: The number one property type to finance outside of apartments is grocery-anchored retail. We’re looking for well-located, attractive grocers with high sales per square foot relative to their peer group. One question to ask: Are they good operators? We also look at the rents the grocer is paying to see if it’s an attractive rent compared with market rents.
REBO: Which property type are you least enamored with and why?
Padilla: B-class suburban office is trading at way below replacement cost. It’s not that the product isn’t financeable, but it’s going to be a long time before we see suburban office speculative development because of the large gap between replacement cost and current value. The office sector, particularly suburban office, has just been a poor performer over the last 10 years. The only way to really turn the office market around is through job growth.
REBO: The commercial mortgage-backed securities (CMBS) market has experienced a rough patch this year. During the summer months, investors began to demand much higher yields for perceived greater risks. What’s the source of the turbulence?
Padilla: My impression is that the fiasco with Standard & Poor’s and the downgrade of U.S. debt did more to derail the CMBS market than all this stuff going on in Europe. It was just this total loss of confidence in what the rating agencies are doing. Investors ended up questioning everything.
The gap between what life companies, Fannie Mae and Freddie Mac are willing to price a deal at today versus theoretically what it would take to do a CMBS deal is more than 200 basis points. (The interest rate on a CMBS loan today is above 6 percent for permanent, fixed-rate financing compared with approximately 4 percent from other lending sources.)
REBO: Will the debt crisis in the Euro Zone affect the U.S. commercial real estate market?
It will have an impact, but not directly on commercial real estate. A lot of the capital that we see in the United States comes from outside the country. Capital in the world is so closely connected now that you can’t presume that there will be a continuous low-cost capital source for commercial real estate in the United States, if you have this kind of collapsing financial situation in Europe.
I just read that Goldman Sachs holds billions of dollars in Italian bonds. Who knows in the banking community how much is held there? All those issues will ultimately have an impact. However, what is going on in our particular business up to this point is simply this incredibly low cost of capital driven by a flight to quality.
Even though we look at our own financial situation in this country — the U.S. government has too much debt and a budget deficit it can’t seem to solve — the U.S. is still a safe haven that helps drive down our capital costs. At least that’s been the story this year. The net result is that we have an asset class that is desirable and a low cost of capital. If you are in the business of distributing that capital like we are in the mortgage business, it’s a very attractive time.
— Matt Valley