Understanding industry dynamics is essential to navigating volatility

Richard M. Gatto, executive vice president, The Alter Group

As published in Scotsman Guide's Commercial Edition, May 2012.

Commercial mortgage brokers have  to deal with mixed signals in today’s marketplace. Despite apparent recovery in the nation’s macroeconomic indicators, lending remains tight as banks cannot shake off the over-cautious approach adopted in the aftermath of the financial crisis.

There also are a myriad of interrelated market dynamics — from struggling financial institutions to global economic uncertainty — that have continued to curb lender appetite and further complicate a much-needed recovery in the commercial real estate market.

It is not all bad news, however. The commercial real estate industry has seen some positive indicators this past year. For example, the nation’s total office absorption was 34.6 million square feet in 2011 — nearly three times the occupancy gained the year before, according to Jones Lang LaSalle. With large blocks of space taken off the market, a gradual recovery in commercial real estate’s overall rents and vacancy rates seems to be in sight — even though construction starts and property development are at record lows.

Commercial mortgage brokers who are striving to navigate their way through the industry’s ups and downs need to have a full understanding of the factors that control lending and other aspects of the industry. Here are a few points to keep in mind.

Unhealthy banks

Financial institutions, including banks, are still struggling. The interbank interest rate (Libor) is one benchmark that can indicate the current lending uneasiness. The U.S. Libor rate was 1.05 percent this past March, up from 0.77 percent a year earlier and the highest level since July of 2009. Essentially, banks aren’t letting their guard down yet.

In addition, changing regulations are adding to the uncertainty in the market. Basel III and Dodd-Frank regulations are highly unpopular — yet of vital importance. The main point of concern, according to the business journal of McKinsey & Company, McKinsey Quarterly, is that the U.S. banking system will need substantial capital in retained earnings or new equity to meet the new capital-adequacy standards — assuming the current asset level and mix.

Banks may see their returns fall by two-thirds unless they take steps to limit the fallout from tougher regulation. In some businesses, a portion of the high regulatory costs may be passed successfully on to consumers, McKinsey Quarterly reports. By some accounts, banks may need $500 billion in new equity to meet the requirements of Basel III and Dodd-Frank.

CMBS

Commercial mortgage-backed securities (CMBS) aggregate issuance hit $32.7 billion this past year, 7 percent short of analysts’ expectations as a result of uncertainty in global markets, according to Standard & Poor’s.

The volume, however, is an impressive comeback after only $12 billion was issued in 2009 and 2010 combined. The commercial mortgage market clearly needs this sector to recover because it remains the fastest in terms of timing and offers loan-to-value ratios (LTVs) in the 70 percent to 75 percent range, unlike the life companies.

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