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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   November 2009

Filling the Void

Borrowers need capital, and brokers often can find them short-term loans to bridge the gap

Although many people think interest rates must decrease again for the commercial real estate market to recover, mortgage professionals and borrowers must accept the idea that the cost of capital has returned to a normalized, more realistic position. Further, market recovery may depend less on interest rates and more on the availability of capital, which remains constrained.

Mortgage brokers who help their clients understand these factors and who know where to turn to fund their clients' deals on at least a short-term basis can best help their clients survive in the long term. Many brokers and borrowers are turning to private lenders to get through today's market.

The dramatic decrease in the cost of capital we saw in the past several years was unprecedented and artificial. The drop in rates along with the opening of the capital spigot took attention away from real estate fundamentals and discipline, replacing sound underwriting with a reliance on financial engineering.

Now, however, pricing is more realistic from a historical context, which should provide checks and balances against irresponsible investing going forward. 

Statistics from the Real Estate Capital Institute show that between 1992 and 2001, interest rates (five-year and 10-year combined) generally fluctuated between 7 percent and 9 percent. This contrasted sharply from the previous decade, in which rates stood between 11.5 percent and 15 percent.

Regardless of the cost of capital, however, the availability of long-term financing is a larger issue in today's market. 

For any substantial thaw in the frozen capital markets to occur, property values likely still must decrease to more-sustainable levels. Depending on the market or property type, this could be as much as an additional 10 percent to 20 percent, which should then help attract capital back into the market and stimulate meaningful transaction volume. 

Until that time -- which many analysts forecast will be in 2012 -- many mortgage borrowers need interim financing to bridge the capital-market gap.

The larger investment and commercial banks, life-insurance companies and even regional banks have capital constraints or have closed. Funds are still available to commercial borrowers, however, albeit on a short-term basis through private lenders.

In fact, an increasing number of private lenders are raising billions of dollars through a variety of debt funds. Private lenders are backed by private equity, and they often keep loans on their balance sheet. Their sole interest is to derive returns based on stringent investment criteria, and they are not federally regulated.

Many of these private lenders are traditional finance companies and make traditional bridge loans at reasonable rates. These lenders can help borrowers survive the real estate crisis in the short term until long-term financing returns.

Brokers are well-positioned to help their borrowers find funding through these private lenders. Not only will doing so demonstrate the ability of relationship-based intermediaries to facilitate successful transactions in this marketplace, but it also will show borrowers that short-term capital can fill a void where long-term financing normally would have been available.


 


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