Commercial Lending Forecast

Softening standards with a chance of loans

Back Article Apr 1, 2014 By Bill Sessa

This year could provide some of the first expansions in bank lending since 2008. So is the market back up to speed? No. But banks are slowly and smartly increasing their appetites for commercial lending, and the Capital Region will see its share of transactions.

Since 2007, all but a few large banks with clean balance sheets have been conservative regarding new lending while trying to get loans repaid. Now, more banks, including community banks in the Capital Region, are looking more favorably at real estate. PricewaterhouseCoopers, in conjunction with the Urban Land Institute, earlier this year released its “Emerging Trends in Real Estate Report.” In it, 43 percent of the industry experts surveyed said they expect debt underwriting standards to soften slightly this year and in the years ahead. Though lenders are now far more cautious than they were in the first half of the last decade, “lending rules are trending to [those seen in] pre-recession times,” said one commercial real estate manager quoted in the report.

Additionally, expected higher interest rates may incentivize banks to once again pursue more loans. According to the PwC/ULI report, real estate loan delinquencies for banks and commercial mortgage-backed securities lenders are declining. As those loans mature, they will free up room on bank balance sheets for new ones.

So how competitive will the market be for commercial real estate this year? Comstock’s sat down with Five Star Bank President James Beckwith, commercial real estate broker Ken Turton and John Weubbe, executive vice president and commercial banking director of River City Bank, to get the answers and assess the financial health of the Capital Region.

Comstocks: Is the Sacramento of 2014 a more attractive market for commercial real estate investment than it has been over the past few years, or are you retaining the caution produced by the recession?

James Beckwith: “The Sacramento market has gradually improved from the depths of the recession, even if it’s still nowhere near where it was. There is some optimism in certain areas, such as downtown and midtown, with interest in the [entertainment and sports complex]. In some areas, such as Roseville, Elk Grove and south Placer, there is some absorption of empty space to be done.”

John Weubbe: “Sacramento investment opportunities are much better than two or three years ago, but the returns are not even close to what they were (before the recession). In general, businesses have weathered the downturn, and things have improved modestly. Things are doing better in the coastal areas, but Sacramento mirrors what happens in the Midwest. We have to wait for things to come to us. Sacramento has always been a real estate-driven economy, and it could be more robust than it has been in previous years.”

Ken Turton: “There is plenty of money to be lent, if you qualify. Lenders haven’t forgotten what happened just a few years ago during the recession, but they are also more sophisticated and have a better understanding of risk. The liquidity of real estate is better than it used to be. It used to be scary if you had $3 million invested in a building and wanted to sell it. Now, 100,000 people will see that listing in a short time, and some of those buyers will be easier to fund.”

Comstock’s: What types of projects are now likely to get loan consideration that would not have a few years ago?

J.B.: “We’re entering some conversations with homebuilders that we would not have had just a few years ago, since the housing stock is not what it used to be. If you look at the Sacramento market in general, where there are rooftops there is job growth.”

J.W.: “But not everybody is hunky dory. They won’t be until we see more positive job growth, and that stems from regulatory decisions. The Affordable Care Act is one example of the uncertainty that makes companies cautious. That relates to how much space they take or how much building they do. Companies are more liquid than they have ever been, but they are still hesitant to expand until they see more certainty in how they are regulated and taxed.”

Comstock’s: Are banks more willing to lend for real estate projects now that interest rates are going up and balance sheets have shed a lot of distressed properties and bad debt? Has commercial real estate become more attractive for investing as yields on bonds and Treasury notes remain low?

J.B.: “The spreads between investment-grade bonds and real estate have always been there, and we’re always going to make more with loans than bonds. The real question is whether someone is willing to take the risk. Does the project make sense? Can the mortgage buyer pay the loan? Are the lease terms appropriate to the loan? In other words, our criteria are the same as always. What happened during the recession and the losses taken by Wall Street and commercial banks are still fresh in everyone’s mind, so underwriters are more cautious and things are more scrutinized. Our standards are the same as they were in the recession years. There are just more deals to look at now.”

J.W.: “Life insurance companies and big banks have pools of liquidity and excess deposits they can use to bid down the spread to try and find a return, I guess. On the whole, my underwriting standards are stiffer than they were in 2005, and they’ve been consistent since 2008. If we like a deal, it’s because of the price. In banking, you have to be right 95 times out of 100 to break even and 99 times out of 100 to make money. We can’t afford to be wrong. On the commercial side, if people have a project we will compete aggressively on price, and we can be more nimble or flexible than big banks. We’ve done 10- and 15-year terms, but shorter terms are generally better in a rising-interest environment.”

K.T.:  “There are a lot of variables in the commercial office market. Rising interest rates could be disastrous. Most buyers amortize a building over 25 years, but loans are for three, five or 10 years. If loans come due when interest is at 7 or 8 percent, it could be a problem.  The Fed has been buying $85 billion worth of bonds every month to keep things afloat, and if they taper that, it sends a little scare into the market. Hopefully, they will do that moderately.   

Comstock’s: Are new capital reserve levels required by Dodd-Frank or other regulatory mandates affecting the amount of money available for commercial real estate lending?

J.W.: No, but banks are working in a more regulated environment that can compress earnings. The Money Laundering Act and other regulations require us to do more to document processes and prove compliance, do more background checks and more training of our employees. Big banks can spread those costs and enjoy an economy of scale. Smaller banks have to outsource some of that.”

Comstock’s: Is there much foreign investment in the Sacramento market?

J.W.: “No, there isn’t much. I was in Sacramento when the Japanese were spending money here in the 1980s. We don’t have anything like that now.”

J.B.: “But there is a distinctive possibility it will happen when the arena and all the related investment comes to this market.” 


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