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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2009

Working Harder, Working Smarter

It's not one or the other anymore as capital-market turmoil amplifies brokers' duties

Working Harder, Working Smarter

An evolutionary moment is fast approaching the commercial mortgage-brokerage industry.

According to The Real Estate Roundtable, a nonprofit public-policy organization, maturing commercial real estate loans will exceed $1.4 trillion in the next few years. The maturing debt may increase demand for commercial mortgage brokers' services significantly.

Closing deals successfully, however, will be an elusive goal for brokers in this capital-constrained environment where debt- and equity-providers are consumed by caution and conservatism.

To succeed, brokers must know how to underwrite the opportunity intelligently, what structure to apply to mitigate risks and which lenders can really deliver the necessary capital in a timely manner.

Here's what brokers need to know about how adapting their businesses and demonstrating these skills will put them at the top of their profession.

•  •  •

The combination of massive illiquidity, deleveraging and devaluation, and the worst recessionary economy in decades has caused upheaval in the commercial real estate industry. Brokers must adapt to the dearth of available capital and recognize changes with regard to where to procure loans for their clients' deals.

The Urban Land Institute's (ULI) 2009 "Emerging Trends in Real Estate" study reported that in 2008, 80 percent of all outstanding commercial real estate debt was held by banks (57 percent) and commercial mortgage securities (23 percent). Domestic commercial mortgage-backed security (CMBS) issuance dropped about 95 percent in one year from its peak in 2007, however, and there has been virtually no issuance in the past year.

Meanwhile, banks face their own pressures. In a late-2008 Federal Reserve survey, more than 80 percent of bank respondents indicated that they were tightening their standards for commercial real estate loans. While that percentage has decreased recently, the current level is close to the peak recorded in the early 1990s after the government created the Resolution Trust Corp. to liquidate bank assets.

As available capital has dried up, real estate values also have dropped. The recent ULI study's respondents estimated that valuation levels this year will average 15 percent to 20 percent less than the peak in mid-2007.

Meanwhile, real estate values continue to feel pressure from the unsustainable expansion of leverage and cap-rate compression that occurred between 2004 and '07. In that period, the total commercial real estate debt outstanding grew more than 70 percent while the total equity capital outstanding increased more than 141 percent, according to the ULI's '08 "Emerging Trends in Real Estate" report.

Although cap rates have expanded recently, Property and Portfolio Research finds that they still remain below 20-year historic averages for the four major commercial property types. The dynamic influences of devaluation and deleveraging are working in concert and causing a fundamental shift in how commercial real estate loans and equity investments are assessed.

If that was not enough to challenge brokers' skills, the industry faces an economy in a recession as severe as any have seen in a long time. Job losses since the start of the recession have reached about 6 million and have yet to show signs of abatement.

Unfortunately, the lagging effect of job losses on rental rates and occupancy levels means that the industry may not experience their full effect for another 18 to 24 months. Real estate valuations and operations will continue to be under stress, and brokers' ability to assess a client's capability to succeed in this new world will affect their ability to survive.

Survival strategies

Now that the two primary sources of capital face regulatory challenges or are essentially nonexistent, it is apparent that brokers must learn new lessons. Getting to know the new funding sources is the logical strategy for mortgage brokers who wish to increase their access to loan dollars beyond the current trickle. Capital is the fuel for the commercial real estate industry.

Private lenders and life-insurance companies will continue to service their niche, and banks that are strong enough will continue to lend to their top-tier clientele. Market demand will far outstrip that supply, however.

Mortgage brokers must educate themselves on all the available sources of capital, understand new product offerings and investment preferences, and build relationships with acquisition and originations staff. These are starting points for survival in a capital market that could be impaired for several years.

In the same way commercial mortgage brokers must look in new places for capital, they also must re-examine how to underwrite real estate loans and investment opportunities. In this environment, capital is once again king, and that means real analysis of the borrower, market, property, tenants and cash flow is required.

The days of consistent 5-percent-or-greater annual rent increases, 5-percent vacancy rates and lax underwriting are over. Solid research, verifiable facts and legitimate market analysis are now essential tools for success. Brokers must tell capital-providers what can go wrong with a loan or investment and how to mitigate those risks.

Further, brokers must add a principal's perspective to the transaction. Not only does this benefit the capital-provider and the relationship between broker and lender, but the client also benefits when the mortgage broker underwrites the loan critically.

The same survival-of-the-fittest scenario is playing out in the property-investor and -developer community as the job market continues to shrink. Developers and investors -- mortgage brokers' clients -- must differentiate themselves as survivors through their balance-sheet strength, niche operation experience or some other means.

Providing extra sensitivity analysis and using research-supported underwriting assumptions -- which may mean applying things such as slower absorption, higher exit-cap rates, and lower or decreasing rental rates -- affirms the value brokers add when they're driven by professionalism, rather than simply closing. That contributes to more-enlightened loan or investment responses from capital-providers, a lower-risk or higher-reward capital structure for property-owner clients, and better relationships for brokers.

There are higher standards established for commercial mortgage brokers, who are expected to meet them. Brokers who fail to adapt their businesses to these expectations risk extinction.

Prosperity awaits

To call the current landscape challenging is an understatement. Unless you have been in the industry for at least 20 years, these are uncharted waters -- and they're tough regardless of your experience. The market is the same for everyone; having experienced the early '90s is neither a panacea nor a major competitive advantage because the industry has grown and matured significantly since that time.

Working harder and smarter commonly were used in an either-or way during the peak of the cycle. In this recessionary market, however, both are necessary.

To work harder, mortgage brokers must invest time, money, effort and relationships with their existing clients. To work smarter, they must assess current clients critically to ensure they are the survivors. If not, they must replace clients who don't meet the standard. And they must expand their client roster with developers and real estate investors poised to prosper in this environment.

Ultimately, driven, achievement-oriented mortgage professionals will learn, adapt, and work harder and smarter to incorporate new realities with tried-and-true fundamentals to survive and to move further to prosperity.


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