Ella Yurkevich
Loan coordinator, Marcus & Millichap
The California Mortgage Brokers Association held its 22nd Annual Western States Commercial Real Estate Finance Conference in Las Vegas in early September. The conference focused on the current state of the commercial real estate debt and equity markets and attracted a significant cross section of lenders and originators, who serve geographic areas within the Mountain West, Southwest and Pacific Northwest regions. Below we discuss insights presented from the lending partners and speakers at the conference.
Yurkevich: In today’s rapidly changing market, it may be difficult to understand the economic environment behind the headlines. What was the general sentiment among the lenders?
Phillip Gause
First vice president, capital markets, Marcus & Millichap
Gause: The general sentiment is that there still is plenty of money available throughout the capital stack that lenders are looking to place. While they are coming across some challenges around understanding appropriate valuation and durability of cash flow on certain transactions, particularly in markets that have had a big run-up in value like Denver, there is a lot of competition for property types such as industrial and multifamily, as well as almost any property type located in core markets with good demographics.
Yurkevich: The conference focused on the Western states. What are some advantages of the West Coast as opposed to other markets?
Gause: We’re seeing more lenders who historically have not had a large presence in the Western part of the U.S. (particularly Colorado and Utah) enter the market. For them, it’s a good way to diversify their loan book while earning a solid risk-adjusted return. The Western part of the U.S. is where a lot of the net in-migration and economic growth is happening at the moment. So, lenders believe these markets will hold up better in a down turn – as they did during the last cycle.
We also are seeing lenders, who have traditionally focused on the West Coast, now looking to do more deals in the “sand states” and the Mountain West as a way to follow their customers and to get out of a potentially challenging political and regulatory lending climate.
Yurkevich: You mentioned an economic downturn. Reports of an impending recession have become more common. What is the general sentiment among the industry experts?
Gause: Everyone seems to think that a recession is still at least a year or two away – much like they have for the last three to four years.
The reality is: Business cycles don’t die of old age. Eventually there’s some event that triggers a correction. When that finally happens, many in the economic forecasting community project that it won’t last as long or be as severe as the last downturn. Some say that a downturn may actually have a neutral or beneficial effect on real estate as a result of lowered interest rates.
Lenders still are bullish on real estate as an asset class despite uncertainty over interest rates and the economy in general. And when you have a market that continues to show job growth and solid net in-migration like Denver – that certainly helps to soften the blow of any weakness nationally.
Yurkevich: How are investors preparing for a possible market correction?
Gause: We’re seeing a lot of our clients do two things. First, they’re really doing a deep dive on their portfolios and trying to figure out what they want to hold through the cycle and what they want to part ways with.
This includes divesting stabilized opportunistic or noncore assets in favor of core and core-plus. Right now there really isn’t as much of a cap rate delta between the two as there has been historically, which implies that noncore assets are relatively expensive, especially when considering the elevated risk profile.
Secondly, they are recapping the assets they want to hold and locking in long-term debt, with up to 35-year, fixed-rate terms, which is really cheap at the moment.
Yurkevich: When it comes to interest rates and staying competitive, how do various types of lenders compare?
Gause: At the time of the conference, there was a lot of buzz about the future of agency lenders in the multifamily finance market. They became a lot less competitive over the last couple of months due to concerns over production caps imposed by their regulator, the Federal Housing Finance Agency. However, those issues appear to have been addressed and we anticipate another strong year of originations from both Fannie and Freddie in 2020.
The life companies still are very competitive at this point in the year. Unlike many commercial banks, they still have an appetite for multifamily construction-to-permanent financing at attractive rates and structure.
West Coast banks are fairly aggressive on pricing and loan structure. They have more leniency in their guidelines. Although most portfolio lenders prefer to push on pricing but not on loosening their credit guidelines.
Yurkevich: Where does this leave commercial mortgage-backed security lenders?
Gause: They had a slow start to the year, but they’re coming back around. They’re competing hard for multifamily deals, as well as office, industrial, retail, self-storage – the traditional product types.
They’re winning business because they typically can offer a lower rate floor, more interest-only loans than life companies or banks, and up to 10 years full-term on a 10-year note. That’s important to a lot of investors as it dramatically reduces the risk of cash-flow issues down the road if occupancy slips or a major tenant blows out of their property.
Yurkevich: What is prompting new lenders to enter the market?
Gause: For starters, real estate is a good way to earn yield on a risk-adjusted basis. They’re able to find a market niche as a response to the regulatory environment. Many new lenders specialize in bridge financing for acquisition or recapitalizations of value-add B or C class buildings, condo conversions, developments, land, etc.
Yurkevich: How do investors benefit from the surge of new lenders?
Gause: These new lenders are having to offer more aggressive pricing, loan dollars and structure in order to win business away from incumbent or relationship lenders.
Generally that’s a good thing for the market as it forces existing lenders to stay competitive and more choices usually are better than fewer choices.
However, the devil is often in the details and borrowers who sign up with a new lender should know what they’re signing up for, which is why it pays to retain qualified capital markets representation when negotiating terms with a lender they haven’t closed with previously or one who is new to the market.
