BANK LOANS

Banks are not in the loan term fixed rate business, but their rates are attractive.  Banks are offering short term loans (3yr-5yr) at attractive rates keyed to short term swaps or Treasuries yields.  However, the favorable rate is offset by the high risk that at loan maturity in 2014 – 2016  the property will require refinancing in a future higher interest rate market and a higher cap rate market, or both.  If rents do not escalate during the term of the short term loan, then the result will be that refi loan proceeds may not equal the amount of maturing debt which must be paid off.

LARGE LONG TERM FIXED RATE LOANS

Many lenders (except Fannie and Freddie) are hedging risk by keeping LTV moderate.  There are exceptions, but the 75% LTV for commercial real estate is still considered an “exception”.  In contrast, Fannie Mae will lend on apartments up to 80% LTV under some circumstances.

Generally on larger life company deals and CMBS deals ($10M minimum), a best-in-class rate today on what would be considered a maximum leveraged loan would be 5.50% -5.75%.  On 5/5/11 the 10 Yr T Yield was 3.16%, the lowest point since the first week of December 2010.  Spreads are also contracting currently so rates for larger deals may reach new 2011 lows in the short term.  Smaller deals will not enjoy the same low rate level as larger deals.

SMALL LIFE COMPANY LONG TERM FIXED RATE LOANS

As a market indicator for small (~5%M) long term, fixed rate loans, below are lending criteria adopted by a life company which specializes in small commercial property loans, i.e., loans in the $2M – $6M range.  This lender has remained active throughout the capital markets collapse.  However, like most life companies, large or small, their underwriting criteria remain very cautious.

Small Life Company Criteria:

• low leverage, typically 60% – 65% LTV
• high DSCR, average deal is 2.08 DSCR
• limited cash out, generally no cash out on refi
• low cash flow risk, diversified rent rolls with no lease hangout for major tenants
• average loan size $4M, loan range $2M – $6M and up to $10M for conservative transactions*
• recourse required on some deals
• loan term: 8yr – 25 yr, fixed rate
• self-amortizing loans (15yr – 20yr – 25yr) are available in conservative situations.  Typically self-amortizing loans will tend towards shorter amortization, versus longer amortization, so cash flow to borrower is more constrained.

*presumably the life company does not consider its standard underwriting requirements above to be “conservative” so the have yet another class called “conservative” into which they put bullet-proof deals.  After the S&P notice of “negative” outlook for US Treasury bonds, the life company may consider Treasuries to be high risk.

PROSPECTS

It is likely that during Q3 & 4 2011 more lenders will become active in the loan range <$10M, which is currently a very underserved market.  We have already seen some aggressiveness with lenders concerning choice properties in the larger loan category.  Part of that aggressiveness is evidenced in the willingness of CMBS lenders to consider Secondary or Tertiary Markets* such as Boise, Idaho.

Owners with properties which have no hair on them will consider to be well received by lenders; however properties with hair on them…not so much.

All lenders are concerned with borrower financial strength, even nonrecourse lenders.  Their object is to place the loan in the hands of someone who has sufficient liquidity and financial wherewithal to withstand bad news, should bad news be found in borrowers path.  More so, recourse lenders (banks and small life companies) are even more concerned about the quality of borrower assets and borrower liquidity.  Bank lenders may have short memories, but they are not so short that the banks have forgotten the bind created when borrowers with illiquid assets confronted the reality that Cash Is King.

The good news is that effectively all lenders have short memories and as soon as they can rationalize looser standards, especially in the face of keen competition, they will abandon their virtuous behavior.

Recall how Charles Prince, deposed CEO of basket-case Citibank observed before the crash:  ”As long as the music is playing, you’ve got to get up and dance,” he said. “We’re still dancing.”  Capitalism’s “creative destruction” **is always preceded by the marvelous effect of competition causing creative irrational exuberance.

*If “Secondary” or “Tertiary” were defined according to risk, rather than size and perceived importance, then Boise would have to be considered a Prime Market.  Remember, however, no one ever accused lenders of being smart.  You probably would not even deal with them were it not for the fact that they have all the money.

** A term coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942) to denote a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”