Certain capital sources, namely banks, are reporting somewhat more stringent lending standards for commercial real estate investments, according to the latest Federal Reserve Senior Loan Officer Opinion Survey conducted in April 2016. Some banks reported tighter standards for loans against industrial, hotel, retail, and hotel properties, and more have given increased scrutiny to the underwriting of multifamily loans. Of those who stated changes in spreads, all indicated that the rate over cost of funds has “somewhat” increased. These tighter lending standards and widening spreads have not stopped the increase in demand for commercial real estate loans: over a third of respondents reported increased demand over one year ago. Presumably to balance the banks’ desire to meet market demand with reduction of perceived risk, a fraction of banks have responded by increasing loan sizes but lowering the maximum LTV on loans, or by applying more exacting demands on DSCRs than in years past.
The conductors of the survey would have been remiss in not inquiring about recent issues in the CMBS market, and the responding banks provided some insight: of those who state that conditions in the CMBS market has affected the volume of CRE loan originations and securitizations, all reported either a moderate or substantial decrease in the past six months. Assuming a typical 10-year term, a large number of CMBS loans originated in 2006 will need to be paid off or, more likely, refinanced this year. When asked how they would evaluate these loan applications in contrast to other commercial real estate loans, 75% of respondents said that they would use the same standards, while 25% indicated that they would use at least “somewhat tighter” underwriting standards.
When asked about the difficulties CMBS borrowers might face when it comes time to refinance, President and CEO Kip Dunkelberger of Venture Mortgage Corporation, a commercial mortgage banking firm headquartered in Edina, MN, opined, “The issue is that many of these loans were issued between 75-80% loan-to-value; some originators were able to push that ratio as high as 83%, or more.”
Pressed for more detail regarding what this means for closing on a new loan, Mr. Dunkelberger continued, “When terms like these are combined with long amortizations and months or years of interest only payments that don’t reduce the principal balance, borrowers find themselves needing to refinance a property at around 80% just to pay off the original mortgage, and most lenders aren’t comfortable with that ratio today. These principal borrowers are realizing that they may need to bring cash equivalent to around 10% or more of the loan amount to close, and they were largely unprepared for that possibility at the time the loan was structured. Commercial real estate investors looking to refinance generally are not willing to infuse additional equity at closing, beyond expected closing costs.”
It is expected that banks and other lenders will pick up some of the slack for these potentially problematic refinancing situations, but the high LTV ratios combined with increasing federal regulation in the commercial real estate financing sphere could diminish lenders’ appetites for these loans. Experts project that almost 30% of current CMBS loans will have trouble refinancing through 2017, and some of these assets will need to be sold or end up in foreclosure. However, borrowers may find some relief due to asset appreciation: commercial real estate prices have doubled in the aggregate since 2010, and the market overall is experiencing ongoing strong demand, increasing rents, and high occupancy.
Contact Venture Mortgage at 952.893.1877, or via email.