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Commercial Department: Q&A: Randy Fuchs, Boxwood Means Inc.: November 2006

 

Q&A: Randy Fuchs, Boxwood Means Inc.

Randy Fuchs, Principal, Boxwood Means Inc.

The growth of small-balance commercial loans — aka, commercial loans of less than $5 million in value — has been something of a loosely guarded secret in all corners of real estate finance.

Buoyed by increased attention from commercial lenders, in addition to an influx of residential brokers closing small-balance commercial loans, market volume grew to $118 billion in 2005, according to independent research firm Boxwood Means. And it’s likely not done.

This past summer, Scotsman Publishing teamed with Boxwood Means to poll Scotsman Guide readers’ thoughts on the small-balance commercial market. Most thoughts were good: 94.5 percent of the 205 brokers polled expressed optimism about their small-balance business, while more than half of the nearly 100 polled lenders had plans to expand their wholesale-commercial-broker network in the next six to 12 months.

We asked Boxwood Means principal Randy Fuchs more about the survey results, which will be released this month.

Why is this survey significant today? There has been a heightened interest in the past year by commercial and residential lenders in this area. Residential lenders are looking for other sources of revenue, given that the housing markets are slowing down. On the commercial side and in the [commercial mortgage-backed securities] world, the competition is so great that those lenders also are looking for other areas and higher margins in small-balance.

People need information about it as it grows.

To what type of audience was the survey directed? The survey offers new and existing participants unique insights into current practices, as well as [into] the challenges and opportunities in the small-balance space. For instance, lenders can benchmark themselves against other lenders in terms of how much of their loan business is sourced via the indirect channel, how much is split between investment versus owner-occupied properties or what percentage of their loans is originated with full, light or no documentation. Moreover, brokers can compare themselves to other brokers on topics such as how they source lenders and what lender attributes are most important, among other issues.

When asked to name the primary challenge to the small-balance market, 27.5 percent of lenders chose a “high degree of market fragmentation” — making it the most-popular response. What kind of market fragmentation are we talking about? Just the thousands of brokers and lenders in the space. It’s a function of the fact that there are so many small commercial properties — we track more than 3 million. The sheer size of the inventory kind of triggers a lot more players.

At this point, the barriers to entry [in small-balance commercial loans] also are low. If you’re a residential broker, you can get in. Residential brokers can capitalize on existing customer relationships to find small commercial or multi-family deals. There is a lot more interest among other lenders trying to cultivate that. Basically, we’re going to see a lot more players.

Taking this into account, as well as previous reports that the top small-balance lenders have single-digit market share, would you say the small-balance commercial loan market would reach any type of ceiling in the near future? You mean when does the market become oversaturated? It depends on how people make their living. Some are fine doing two to three deals a year. Some need 15 to 20 each year.

If the [commercial-mortgage-backed securities] market is any indicator, we’ve got a ways to go. Let's not forget that securitization in the small-balance space is still in the first inning.

Despite the uncertainty in the economy, brokers and lenders remain quite optimistic about business. And according to the survey, brokers and lenders are ahead of 2005’s totals for small-balance originations.

After fragmentation, lenders cited “inadequate market information” as the second-biggest challenge in the small-balance market, followed by high underwriting costs and a lack of standard documentation. Does that surprise you? I’m not surprised by those answers — that’s why I put them in there. Really, market fragmentation is a situation where there is difficulty sourcing lots of deals and cornering this market. And though there are a lot of sources out there who help commercial lenders get a sense of what the market is doing, that’s not the case for smaller properties. There are no standardized, accessible sources of information.

What did surprise you, on first glance of the survey results? [More than] 70 percent of lenders said they had a small-balance program in place [for more than a year], which shows that there is a fair amount of focus on this area. That was a little higher than I thought.

Earlier this year, you noted that the small-balance market saw 11-percent growth in 2005. At this point, how is 2006 shaping up? What’s next? I think origination volumes will continue to grow at a steady clip, assuming the economy remains stable. We’ll see more competition as large residential lenders come into the space, and I think that we may see some consolidations like what we saw on the residential side. It’s a healthy, broad and diverse market.


 

Tony Stasiek was an editor at Scotsman Guide. For questions on this article, call (800) 297-6061 or e-mail articles@scotsmanguide.com.

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