‘Hostile’ Lending Environment Weighs on Investors

The skies are ominous for real estate investors, especially those seeking financing.Take the failure last week of Silver State Bank of Henderson, Nev., which had about $2 billion in total assets. The bank’s collapse — the 11th such failure so far this year — follows an announcement last month by the Federal Deposit Insurance Corp. that the number of banks on its “problem list” rose 30% during the second quarter of 2008. At the end of June, there were 117 banks on the agency’s watch list, up from 90 at the end of March. Representatives from the FDIC and other government agencies are saying they expect the problem list to grow.“The current lending environment is hostile and bank loans for real estate are a challenge to secure,” the vice president at Pacific National Bank, Edward Lombardo, said. “The real estate portfolios at U.S. banks are declining, while noncurrent loans and charge-offs have increased significantly, hurting the profitability of banks. Underwriting standards for banks that have in the past provided real estate financing have tightened by 80%.”The tightening of credit is having a drastic effect on investment sales. As reported by research firm REIS Inc., such sales “are expected to fall 66% this year from $467 billion to an estimated $159 billion because debt, especially securitized debt in the form of commercial mortgage backed securities, is either unavailable, or prices are too high and terms too strict for borrowers.” As I reported last week, Wall Street failed to issue a single dollar of CMBS debt during the months of July and August.Many investors and lenders are waiting on the sidelines for prices to drop. Investors are testing the waters to ascertain if properties can be sold, yet few buyers will consider purchasing without a firm commitment for financing. The combination of a drop in the volume of office leasing with a reduction in asking rents is creating havoc for sellers who are unable to meet their existing debt.“Many major banks are drastically reducing their real estate originations or, in some cases, shutting down altogether. This is the result of intense capital pressure combined with weakening national fundamentals in real estate, especially for residential sales,” Michael Slocum, the executive vice president of Capital One’s commercial bank, which represents more than $25 billion in loans and generates revenue of more than $1 billion, said. “Relationships are key with lenders who are still providing capital. Credit standards have tightened somewhat and credit spreads have widened. While the actual movement hasn’t been that dramatic for portfolio lenders, it may seem so to borrowers if they are comparing it with the more aggressive securitization market of a year ago. Securitization markets and syndication markets are also closed, which is making it difficult to find financing for larger deals, as banks, regardless of size, want to limit their exposure to any one transaction.”Financing for new condominium developments and land has basically dried up. If financing is possible for a proposed condominium, the basic terms would require the borrower to have at least 40% equity and provide full recourse to the financial institution, coupled with stringent covenants for the transaction.Even though New York City continues to have a need for hotel financing, the market for lenders is diminishing on a daily basis. Since the beginning of the year, at least 30% of the lenders who previously entertained financing for the hospitality industry have stopped providing financing. Few, if any, commercial banks will provide financing for proposed limited-service hotels. If financing is offered, borrowers are now required to have between 40% and 50% of equity, provide full recourse, and plan to pay for the financing fees, which range between one and two points, and floating rates of LIBOR plus 350 to 600 basis points.“The story remains the same: Banks are under pressure from their regulators to underwrite loans for income producing properties on a cash flow basis,” the chairman and chief executive of Intervest Bancshares Cor., Lowell Dansker, said. “For construction and development, the sponsors must exhibit the ability to support the loan with personal cash flow and liquidity or, in the alternative, enough cash equity investment in the project to eliminate the lender’s risk. In the current environment, no lender wants to ‘stick his neck out’ by making a loan that does not solidly meet those requirements. That being said, rates are still low and funds are available. As prices come down, some of the capital that has been sitting on the sidelines will begin to be deployed for acquisitions. The injection of this new capital into the market will help ease the regulatory concerns, thus removing the chilling effect and uniting the lenders’ hands.”One bright spot is that lenders remain bullish on the financing of residential rental properties in the five boroughs. “Stabilized residential real estate is an asset class for which we continue to have a desire to provide financing, particularly for established borrowers,” the senior executive vice president and chief credit officer at New York Community Bank, James Carpenter, said.“We are bullish on multifamily housing in the boroughs,” the chairman of the board of the $6 billion Signature Bank, Scott Shay, said. “During the last 12 months, while other banks are retreating from the market, we have provided close to $1 billion in real estate loans.”Domestic and German financial institutions continue to be active in providing letters of credit for so-called 80/20 projects, where the New York State Housing Finance Agency and the New York City Housing Development Corp. offer tax-exempt financing for developers of multifamily rental projects. According to the federal tax code, at least 20% of the units must be set aside for households with incomes at 50% or less of the local area median income, adjusted for family size. Alternatively, 40% or more of a project’s units (25% in New York City) must be “affordable” to households whose income is 60% or less than the local AMI, adjusted for family size. For example, Wachovia and Helaba Bank last month helped finance Forest City Ratner’s 34-story, 365-unit 80/20 rental development.Financing for other asset classes remains a difficult task for a borrower. “Given the current market conditions and the uncertain outlook, lenders are less likely to take construction or market risk, thus land, hotels, for-sale residential, or deals with significant leasing risk — excluding multifamily — are very difficult to get done,” Mr. Slocum said. “Portfolio lenders are underwriting more in-place cash flow and current market conditions, not pro-formas or upside scenarios.”I am trying to be an optimist on the state of financing for commercial real estate, and must concur with Mr. Slocum when he says that while “market fundamentals in the New York region are weakening, they are still relatively sound.” Underwriting by strong and solvent financial institutions will help real estate investors weather the storm, which may be around as long as 18 months before it ends.Mr. Stoler, a contributing editor of The New York Sun, is a television and radio broadcaster and a senior principal at a real estate investment fund. He can be reached at mstoler@newyorkrealestatetv.com.

‘Hostile’ Lending Environment Weighs on Investors

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