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Sea of Liquidity

By December 26, 2014No Comments

Fred Schmidt, president and COO of Coldwell Banker Commercial, believes debt and equity capital will be more available in 2015. And that’s good news – at least for now – for the recovering commercial real estate market.

The Mortgage Bankers Association has forecast origination by mortgage bankers will rise by 8 percent by the end of 2015, after an estimated 6 percent bump-up last year. That is still a far cry from the whopping double-digit volume pumps during 2011-13, immediately following the Great Recession. But by the end of this year, total commercial/multifamily originations by mortgage bankers will be substantial – at $407 billion, according to the MBA – almost back to the 2007 peak level of $508 billion. Notably, at an expected $173 billion, multifamily financing in particular should exceed its 2007 peak volume of $148 billion.

That makes for plenty of liquidity to drive the commercial real estate market. If anything, capital appears to be constricted currently by the death of appropriate commercial real estate opportunities, rather than by the amount of capital available, at least in the primary and, increasingly, secondary markets. “Everyone complains that there is a lot more money than good deals. …Capital is more aggressive because there are fewer properties; there is a lack of quality out there,” said Danny York, president of Franklin Street Capital Advisors.

The upside for borrowers: York expects the cost of capital generally to be lower this year “as long as it is difficult (for lenders) to find good deals.”

Still, from the lender’s point of view, the quality of deals is set to improve. The higher mortgage bankers originations volume in 2015 will be driven by improving commercial property markets, fundamentals and asset values, according to Jamie Woodwell, vice president of research and economics at MBA. Additionally, after settling at a trough in the past few years, the wave of mortgage bankers’ loan maturities – projected to surge by 72 percent in 2015 – is scheduled to begin this year. Indeed, there is no longer the same grave concern that the capital markets will lack the capability to offer up enough dollars to refinance the big wave of maturing loans – at least, the quality ones.

There continues to be very strong lender appetite to place capital into commercial real estate, said Woodwell. The reason is that commercial mortgages have performed very well through the recession compared to other investment opportunities on a risk-adjusted basis. All major investor groups are expected to increase their debt originations volume this year, according to MBA’s forecast.

For example, life insurance companies experienced a record volume year in 2014, and will see another strong year in 2015, said Woodwell. “The appetite among life insurance companies for commercial mortgages will continue to be strong in ’15 as markets continue to improve,”

Last year saw strong investor demand for CMBS, he noted, and the key question in 2015 is whether, given the spike in loan maturities, there will be significantly higher loan supply for CMBS and “opportunities to increase issuance.”

As for Fannie Mae and Freddie Mac, Woodwell expects a strong fourth quarter for the agencies as the hot multi-family market, loan maturities and robust rent levels carry forward the momentum from year-end 2014. The Federal Housing Finance Agency, which oversees the two agencies, had dictated a 10 percent reduction in footprint in 2013, but did not issue a similar directive for a further 10 percent reduction in footprint last year. Originations fell to well below the 10 percent limit in 2013 and in the beginning of 2014, Fannie/Freddie production volume increased considerably, and volume for all of 2014 will likely prove to be back up closer to the 10 percent cap, he commented.

All eyes will be on the FHFA this year regarding any further directives to change the GSE’s financing limits.

Banks, meanwhile, having pulled back from their financial issues, are expected to be solidly active. These financial institutions “have shown very strong appetite for commercial properties and extremely strong appetite for multi-family. They had shown strong growth in originations and balance of loans held. We are looking for continued strong appetite from them,” Woodwell noted.

Building Bridges

More capital is also expected to flow into construction and bridge financing in 2015, and the strength of the permanent financing market will boost confidence among bridge financing providers, suggested Malcolm Davies, principal at George Smith Partners. “No question, we are seeing bridge players stretch for really good, well-located properties (at LTVs of) 85 to 90 percent or more.” The bridge financing market, said Davies, has strengthened in the past 12 to 18 months because lenders can more easily see favorable exits down the road via disposition or refinance. “It comes down to how liquid the permanent market is now.”

At the top of the capital stack, Davies predicted that the pricing for mezzanine and preferred equity financing will fall farther due to competitive pressures among lenders. He added that there will be more one-stop shops – more mezzanine and permanent lenders will partner to offer seamless, blended-rate combined perm-mezz financing that pushes the leverage up to 85 percent, and in some cases as high as 90 percent. Mezzanine loans or preferred equity on desirable properties is being priced from 7 to 10 percent, and the blended rate can be 5 to 7 percent.

The greater availability of mezzanine financing is also starting to affect the condominium construction market. LTVs for senior construction loans are still about 65 percent, but the mezz pieces the LTVs on the condo construction loan can be brought as high as 80 percent, said Davies.

“Mezzanine will become more prevalent,” agreed York. “There are more mezz lenders in the market.”

Since the end of 2014, said Larry Sullivan, president of Passco Cos., more players have emerged in the mezz market. Foundations, endowments, family offices and high-net-worth individuals are all getting a foot in the door. York ventured that because mezz is cheaper than equity, as more mezz becomes available, borrowers will be switching more equity into a mezz piece.

Even international players are getting involved in the debt market. More investors from Asia and Europe are now not only participating in joint ventures but also providing preferred equity, according to Sullivan. In fact, the company intends to expand its penetration of global capital this year, he said.

There is “competition from all sides of the capital stack,” said Schmidt. And with so much global capital available – and so much more available in general – greater leveraging is now possible, Sullivan noted.

This article was originally published in the Commercial Property Executive January 2015 issue.

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