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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   November 2009

Look to the Past to Determine the Future

Focusing on cash flow, not LTVs,could help the industry get back on track

Thirty years ago, there were no such things as easy-qualifier, no- or low-doc, or stated-income loans. Other widely used terms -- such as yield spread premiums and rebate pricing -- also were mostly unheard of in the commercial mortgage industry. Over the years, however, these programs and incentives made their way into all sides of lending, including commercial mortgages.

In 1989, the savings-and-loan crisis hit the commercial real estate lending community. Many savings and loans associations had underwritten mortgage loans expecting future property values and increased rents to satisfy the potential cash flow of the asset. 

Does this sound familiar?

It may not be d‚ja vu; there are a number of differences between then and now. But for mortgage professionals, looking at history and current events can help determine the future. Essentially, it is time to get back to basics in the commercial real estate lending industry.

Property Trends
Each property-type sector is reacting differently to today's market forces.


  • Multifamily: Has been generally immune to most market downturns. Mounting foreclosures in the residential sector have not necessarily helped the apartment market thrive. 
  • Retail: Hardest-hit, with many retailers either closing or consolidating locations. Some large retailers may still be paying on leases, but any large vacancy in a shopping center hurts other tenants as well as the property-owner's ability to attract new tenants. 
  • Office: Also has consolidated, with employers cutting back on space. The financial and banking markets contribute to the biggest blow to the office market. Active companies often are operating with a smaller staff. 
  • Industrial: When these owner-user properties fail, many vacant buildings enter the market. Smaller owner-user companies showing business stability are taking advantage of the new, lower-cost U.S. Small Business Administration loans available.
  • Hospitality: Hotels and motels are feeling a compression because of the lack of business and vacation travelers. They now have lower occupancies and lower average daily rates.

In the wake of the savings-and-loan crisis, the government enacted the Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA). It started the Resolution Trust Corp. to close bankrupt thrifts and financial institutions and to help these institutions pay back their depositors.

FIRREA also set many standards that most underwriters still use today to keep most commercial real estate loans from falling into the problem that the subprime crisis created. The problem now, however, is that property values have declined. New underwriting has become more conservative to ensure that income-producing properties can support the debt. Vacancies are greater. And many owners have found that their properties' current value is less than the loan balance on the property.

With these and other economic factors in mind, the federal government has created programs -- such as the Troubled Asset Relief Program, the Term Asset-Backed Securities Loan Facility and the Public-Private Investment Program -- to help provide liquidity to the market and help banks resume lending.

Despite these programs, it seems that for the most part, commercial real estate lending has not resumed -- at least not as had been expected. Many banks that have received funds from these programs have not increased lending or at least lending the way it was.

Those that have seem to go back to the basic principle of conventional, commercial real estate lending: Can the borrower repay the debt based on the property's income?

Loan-to-value (LTV) ratios are not the basis on which a conventional, commercial real estate lender determines loan amount. Rather, the basis is cash flow -- or the income the property produces.

LTV reflects what percentage of the property value has a loan on it. Historically, LTVs have been 70 percent to 75 percent for retail, office and industrial real estate and 75 percent to 80 percent for multifamily properties. Now, LTVs are in the 60-percent to 65-percent range across the board.

The exceptions to the cash-flow rule occur in hard-money and U.S. Small Business Administration (SBA) lending. Hard-money lenders, or private funds, typically lend purely on the property value and rarely exceed a 55-percent LTV. With hard money, the idea is that the lender and borrower are partners and that the borrower has as much to lose as the lender. Interest rates may be greater for hard money, but qualifying often is easier. Plus, hard-money lenders usually fund loans within two weeks and have less paperwork than traditional lenders.

SBA loans typically are made purely on the business's income with almost no reliance on the property's potential income if leased out. These loans have a maximum 90-percent LTV in some cases. For these loans, brokers must demonstrate that the client is seeking a loan to be used for business purposes and that the loan will help the client's business.

The key qualifying factor for SBA loans is a business's ability to repay the debt. The business's history and your client's industry background play vital roles in the loan decision. Many banks offer SBA financing, and some offer SBA-lookalike-loan programs, which are a hybrid of SBA and conventional financing.

The commercial mortgage-lending community continues to want to make high-quality loans, and government agencies want banks to resume lending. As brokers recognize that lenders are returning to the basics of low LTVs and a focus on cash flow, the market likely will bounce back -- but it will no longer be like it was.


 


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