After seeing growth in their originations in 2011, many lenders are scaling back their expectations for 2012, said panelists at ULI’s Capital Markets Conference who represented lenders from major financial institutions and smaller debt providers. Greta Guggenheim, president of Ladder Capital, acknowledged that her group is unlikely to reach the $2.4 billion in originations it had slated for this year on top of $1.6 billion achieved last year. Met Life managing director Mark Wilsmann noted that the low—and apparently falling—interest-rate environment will restrain insurance lending, especially for longer-term fixed-rate deals. “The low interest-rate environment is affecting volume. So far,” he added, “it’s mostly in the floating five-year short space. There’s not a lot of ten-year money.” Putting the situation in context, he noted that with life companies’ roughly $450 billion portfolios invested some 90 percent in fixed-rate instruments yielding in the mid–5 percent range, selling bonds for lower yields just doesn’t add up. “We can’t put that money out.”
Charles “Chip” H. Fedalan, executive vice president and group head of commercial real estate at Wells Fargo’s institutional and metro markets group, said, “Wells Fargo is not just a real estate lender,” he said, “and other products are currently providing higher returns.” Wells has scaled back its commercial real estate targets since year-end, he added. “Although we want to be in the market, we’re not required to be in it at all times.” He also agreed that there is “more cash flow at the short end” of the loan-term spectrum, and while the “very low interest-rate environment is good for inflating asset prices, it’s not necessarily good for pension fund and insurance company-dependent retirees.”
Added to that, said Guggenheim, is the financial uncertainty that is disrupting the general capital markets. “We’re very sensitive to all credit spreads, and the hiccups reverberate through to what we can quote,” she said. The gapping out of commercial mortgage–backed security (CMBS) spreads has caused a “dramatic falloff in the fixed-rate pipeline, although the floating-rate volume is picking up.” “Many banks are selling loans at discounts, creating a lot of new business,” she said.
“Deal quality isn’t as great as I [had] hoped it would be,” said Jason Choulochas, managing director at Aries Commercial Real Estate, “and many assets have issues, which is not giving people confidence in future rental growth.” Nonetheless, he added, “we’re trying to pick through a wave of opportunities, hoping to put out $500 million of senior debt.” He reported Aries’s average deal size at around $25 million, and noted a “barbell effect in the deal pipeline,” with small and large deals attracting lenders but less interest in “classic middle-market” transactions.
Scott Weiner, chief investment officer at Apollo Commercial Real Estate Finance, said growth in mezzanine activity could be a market catalyst. “Mezz still offers attractive risk/reward returns,” he says, noting that Apollo is not reducing its output from 2011 levels of about $1 billion. But there is a change in direction: “Last year, we were mostly coming in behind CMBS; now, we’re behind balance sheet lenders” like insurers, sovereign wealth funds, and Canadian pension money.
Panelists differed slightly on benchmarks from loan-to-values (LTVs) to the returns that can be generated by mezzanine loans currently, but were encouraged by recent market discipline in underwriting—such as projections based on current cash flow rather than asset market value. Still, cautions Fedalan, “Debt yields based on NOI [net operating income] aren’t very valuable. NOIs don’t mean cash in pocket.”
On the other hand, panelists noted that new pressures in development and construction deals in multifamily and from competition to make loans are having an effect. For example, said Choulochas, the highest returns are now found in loans backing construction and development.
“Everybody’s trying to find deals,” said Fedalan. “That’s good for borrowers. Previously, lenders were pushing low-leverage, no-risk terms, but the search for yield is re-creating that capital stack. Fortunately, that hasn’t gotten complicated. There is available money across the spectrum.” On senior debt, spreads have tightened on core and “mildly” value-add deals by 100 basis points, allowing mezzanine lenders to step in with room to maneuver.
One signal that appraisal standards are tighter these days: In an aggressive buying market for top-quality assets, industry insiders are starting to see some assets not appraise out.
ULI–the Urban Land Institute