The glut of commercial real estate loans that closed in New York City before the financial crisis has given banks and other lenders a built-in floor of deals that need to be refinanced. A total of $32.1 billion in commercial mortgage-backed securities deals in the city — totaling 1,128 loans — closed between 2005 and 2007 (all set to mature in 10 years), according to the data firm Trepp. Now, as the so-called maturity wave settles, The Real Deal spoke to lenders and borrowers to get a better sense of what will drive the commercial real estate finance market in 2018. Most experts agreed that the influx of maturing prerecession loans has been addressed — whether borrowers refinanced or sold off their properties. But that doesn’t account for all the new buildings and development sites that have come on line in the past 10 years. Now, some argue the New York market has become too competitive with the flood of debt funds and other nonbank lenders in recent years. Even as the supply of traditional construction loans has thinned, due to regulations imposed on banks and concerns about overheating, alternative lenders have entered the market by the hundreds to fill the void and then some. That includes developers with excess capital looking to help (and, in some cases, foreclose on) their peers. “There’s so much capital and a wide variety of choices — perhaps the widest I’ve seen in my career,” said Jerome Sanzo, the head of real estate finance at Industrial and Commercial Bank of China, who’s based in Midtown. But even at that, those TRD spoke to voiced skepticism about lending in NYC across the board — from bankrolling high-end condo projects to financing office, retail and hotel properties.
Executive Vice President, CBRE Debt and Structured Finance
Can you briefly lay out the state of the debt market? In most cases — extremely competitive. Life companies, government-sponsored entities, bank balance sheets, debt funds and CMBS [shops] are firing on all cylinders. Almost all lenders have had a good year and are looking toward getting 2018 off to a good start, so expect the run to continue absent exogenous adverse events.
The maturity wave is about to end. How is that going to affect your business? The maturity wave has been handled in a very orderly manner. Many loans were refinanced or extended long before their maturity dates or were handled through special servicing already, so there has not been a massive glut of deals needing to be addressed at the same time. With respect to our business, we have seen more flow from acquisitions than refinancings in the past year. In a normal, steady state we would expect it to be roughly equal.
Are you seeing the volume of construction loans slowing? The slowdown has already happened. Banks are still willing to lend, but it has to be for the right sponsors, markets and projects. Oftentimes, [those deals] will have very tight structure and a pricing premium. Many of the private equity shops have rushed in to provide capital at the bottom of the capital stack. Those sponsors and lenders are fully capable of completing the project if it ever comes to that, which provides a great deal of comfort to the senior lender.
With an increase in private funds filling the void for construction lending, are you seeing more predatory lending? Most examples we have seen, and the groups we work with, are not predatory in nature, whether it is a debt fund focused on solely debt investments or an institutional developer /private equity firm with a debt arm. These groups sell their investors on fixed-income returns and return of principal at maturity, not a foreclosure and ownership of the property. In fact, they are trying to avoid situations where they might take back the property. They are trying to build a long-term track record as a reliable lender and a viable alternative to a bank.
Are there sectors banks are hesitant to lend on? Limited-service hotels, single-tenant properties, suburban office, ground-up construction and other off-the-run asset classes are segments of the market with limited financing options. High-street retail, regional malls and power centers are all receiving a ton of scrutiny from lenders. The sale/leasebacks, corporate restructurings and bankruptcies among major retailers make it a difficult sector to finance right now. On the flip side, industrial properties are benefiting from the e-retailers’ large space needs in close proximity to the consumers.
What else should we keep an eye on? Credit standards. Are the banks loosening the structural provisions of their loans in order to win business in a very competitive market? Recourse carve-outs, cash management, amortization and escrows, among others, are all structural components that can be compromised if a deal is on the line in a hypercompetitive market. Loose-credit creep is definitely a risk, even with all the regulatory initiatives put in place since the recession. In our estimation, lenders overall have continued to be responsible with loan structure, so that is heartening.
Executive Director and Head of Real Estate Finance, Industrial and Commercial Bank of China
What’s the state of the finance market in New York right now? It’s a very liquid market for finance. My concern is that there’s so much capital and a wide variety of choices — perhaps the widest I’ve seen in my career — that includes commercial mortgage-backed securities, traditional banks, insurance companies. There are also an extraordinary number of nonbank debt providers, so it’s a very competitive market.
What is the environment like for construction loans? Construction financing is a bit more difficult. Some nonbank lenders have been willing to step into the void. We, like a lot of other lenders, are very cautious on new construction finance because there’s a lot in the pipeline already. One Vanderbilt has over 1 million square feet to lease, Hudson Yards has been very successful in leasing, but there’s still several million square feet there, and there is an extraordinary number of condo projects being constructed right now.
There have been a lot of pre-recession loans coming to term. How has that affected business? Generally, the refinancing of the 2006 to 2007 loans has been better than expected. It’s true that not all were able to be refinanced at the same level of the proceeds or with the same prices of the loans. We have refinanced some CMBS loans with bridge loans [when the underlying property is] in transition or when there’s some value-adding possibilities. Keep in mind that the pipeline stopped midway through 2008, so the peak was really in 2007.
In what markets are you seeing the most demand? Besides New York, the hottest markets are still Seattle and the San Francisco Bay Area. Los Angeles is probably up there, too. You see some [activity] in Miami, Chicago and Boston. As a foreign bank, we focus on the primary metropolitan statistical areas.
Do you see acquisition lending going down as Chinese capital controls have become tighter, allowing for less money to leave the country? Demand for acquisition financing will definitely continue to slow down. But we, and others, see demand from other parts of the world like South Korea and from sovereign wealth funds from Europe and the Middle East.
Is ICBC shying away from any particular sectors in real estate, and likewise, is it embracing any? We’re definitely moving away from new office construction, and we’re very negative on new condo construction, nationally. We’re not really entertaining requests for office and condo [loans]. It’s late in the cycle, and deals that we would have been interested in have already been done. We’re still financing some construction for multifamily, but it has to be the right deal and with equity coming in. We are interested in industrial — there’s a huge amount of demand because of e-commerce. We’ll also look at retail in the right locations and with the right tenants.
Senior Lecturer in the Discipline of Finance and Economics, Columbia University Business School
Could you briefly lay out the state of the lending and finance business in New York right now? It’s generally doing pretty well. There were a couple of things that people were concerned with, for example, the advent of risk retention in terms of that reducing CMBS issuances. Really, what it’s done is concentrate more — you’ve seen a number of smaller lenders drop out of the market, but that market seems like it’s still healthy. In terms of the property types that people are willing to lend on, the biggest impact has been on construction. You can still get money for [projects with] moderately sized condos, under 1,500 square feet.
Would you attribute that to oversupply in the higher end of the condo market? Yes — just how many $5 million and $10 million apartments do you need given what’s happening in the economy? Hotels are another problematic sector in New York. There’s been a strong dollar, but the geopolitical noise in Washington, D.C., has put a damper on tourism. And you have all these small budget hotels showing up in the city. The internet has impacted business as well, with alternatives like Airbnb and services that let you know if there are better rates at nearby hotels.
The maturity wave is about to end. How do you see that affecting volume and the general nature of lending over the next few years? There is $25 billion worth of CMBS loans maturing in 2018 as opposed to the $120 billion that matured in 2017. I don’t think lending next year will be as rosy as this year. People will really have to work hard to find new business. While we’ve seen some problems with those maturing loans, it’s nowhere near where people had feared, due to the fact that property prices are up and there’s lots of mezzanine lending available if they need to refinance.
How are nontraditional, nonbank lenders competing with banks? It depends on property type, but generally construction is where we’ve seen the biggest reduction in lending from banks. That has created space for nontraditional bank lenders to participate. One situation is where a traditional bank will provide much less money on a development project, both because of the risk and changes to Basel III and the high volatility commercial real estate (HVCRE) designation, which have had a big impact on commercial banks’ lending. If a traditional bank wants to do a lower loan-to-value ratio, one of these other players can come in.
What else should we keep an eye on? There’s been a shift among some borrowers and lenders toward preferred equity over mezzanine loans. As we said before, with this HVCRE designation, if you have a deal with less than 15 percent equity, the banks are going to charge you higher rates. Some borrowers are getting preferred equity, which would qualify [as having more equity in a deal and in turn] open up more opportunities for people to lend to them.
Founder and Managing Partner, ACORE Capital
How far along are we in the cycle? We are obviously deep into the cycle; however, most market participants we interact with believe the probability of a recession in the next few years is relatively low. Developers executing business plans in the transitional commercial real estate space — which are typically completed within 24 months — are comfortable with respect to where we are in the cycle relative to their objectives.
What does that mean for you? ACORE and its investors are actively lending to high-quality borrowers pursuing accretive business plans. At this point in the cycle, many market participants struggle to see the upside in core assets; however, others have begun to pursue carefully selected value-add projects that can create material gains in property value if commercial real estate markets do not rise in value.
How much more equity are borrowers bringing to deals? In today’s post-financial crisis market, institutional opportunity funds are avoiding excessive leverage. To illustrate this point, ACORE’s loans generally have 30 percent or more equity in them.
Are you seeing more than one lender on each deal? We are a one-stop shop, so in our case, no. Borrowers much prefer to deal with a single lender, which is a material competitive advantage for ACORE. If the loan-to-value on a mortgage is too high for banks and one of the large nonbank lenders like ACORE is not interested, such financing has to be layered.
Are you, or other lenders you know, shying away from any particular sectors in real estate or embracing any? Most commercial real estate retail loans which we see being originated today are on stabilized properties. While transitional retail loan opportunities do exist, ones that ACORE finds attractive are rare.
Head of Finance and Acquisition, TF Cornerstone
Have you seen seen any shift in the lending industry recently? We continue to rely on our relationships with banks, insurance companies and GSEs to provide most of our construction and permanent financings. I hear that balance-sheet lenders have tightened up and have become more selective. We are fortunate to have strong relationships with these lenders, and we haven’t seen a material pullback in their interest in financing our projects.
Do you primarily go to banks or nonbank lenders, or a mix? We generally do not borrow from the nonbank lenders. We are low-leverage borrowers and more focused on maintaining a conservative balance sheet and low cost of capital. Over the past seven years we have been extending our debt maturities and locking in long-term fixed-rate debt. Insurance companies like MetLife, AXA, Prudential [now called PGIM] and New York Life have been actively lending to us. The GSEs are very competitive on the long-term multifamily front. We’re in the middle of a Freddie Mac deal on a large multifamily asset in Manhattan. On this particular loan, Freddie Mac had a more competitive proposal than the insurance company market, but it can go either way with multifamily.
Are banks asking for different requirements, like more equity, in deals? We haven’t seen requirements of any loans change on the balance-sheet side, probably because we aren’t pushing leverage levels like our competitors.
What should we be watching? Treasury rates could have a material impact on property finance and cap rates more generally. As Treasury rates fluctuate, we have to evaluate whether the market has overshot, and we need to shift our financing strategy. The other thing to watch is LIBOR [London Interbank Offered Rate] and how the shift away from LIBOR into other base rates plays out. [LIBOR will be phased out by 2021 amid a series of bank scandals.] We’re still getting our arms around this.
Senior Vice President and Northeast Market Manager, Capital One Commercial Real Estate Group
What is your read on the lending market right now? There is plenty of money available from a variety of sources, both traditional and nontraditional, for good projects with solid sponsorship. Pricing for stabilized and construction loans continues to diverge.
Are there any changes in underwriting? [There have been] no material changes in underwriting, but pricing continues to tighten for stabilized, low-leverage assets.
How much are refinancings driving your activity? Refinancings remain an important part of our business, which is not surprising given that I’m hearing from sales brokers that reported sales activity has been down 70 to 75 percent in 2017.
What is the environment like for construction loans? There is money available, and bilateral deals are getting done with more frequency than larger syndicated loans. Pricing for bilateral loans and club deals — those arranged among a few banks — is better than larger, multiple bank syndications.
Are you partnering with private lenders, particularly on construction loans? We have and will continue to do so, but only with entities that we are comfortable with.
Is Capital One shying away from any particular sectors in New York real estate? We are primarily sponsor-focused and therefore will look at any asset class. Someone once told me that every building deserves a loan — it is just a question of how much!
What should we be watching? People should be watching how the multifamily rental market absorbs the large amount of deliveries happening over the next couple of years — same with the office market. There is lots of new space entering the market in places that haven’t been traditional office areas. It will be interesting to see how the established office districts handle that. People should also keep an eye toward densification trends and how that affects the office market. Lastly, digital disruption of commercial real estate is only now beginning, and people should watch out for the effect on how people experience commercial real estate in the future.