Examining financing for Northeast Ohio’s commercial real estate market

In the modern world of investment real estate lending, banks have to be more than just a place where investors and developers come for money — and this is especially true as more lending players enter the Northeast Ohio market.

The banker works with a developer, taking time to understand their world in order to approve the right deal, says Stewart J. Rea, senior vice president at FirstMerit Bank.

Partnership is a word that gets used a lot in banking. However, Michael K. Dostal, senior vice president and the North Coast manager of commercial real estate lending at FirstMerit Bank, says commercial real estate lending has become more balanced as demand no longer rests as heavily on the side of developers or lenders.

“We want the client to succeed. If we’re underwriting it in a way they feel might be a little too conservative, it’s because we want their property and loan to succeed. We don’t want it to become a problem,” Dostal says.

Smart Business spoke with Dostal and Rea about what they’re seeing as lenders for Cleveland and Akron commercial real estate.

What’s Northeast Ohio’s commercial real estate market like today?

The primary investment real estate types — office, industrial, retail and apartments — are, for the most part, performing fairly well. Values are generally returning to what they were before the market sagged in the recession and the years that immediately followed. Capitalization rates, the rate of return on investment property based on the expected income the property will generate, are improving. Occupancy has grown. People who couldn’t refinance in 2009 and 2010 are finally seeing values close to those pre-recession; they now can refinance with some earned equity in the deal.

New construction, however, remains slow as developers continue to focus on redeveloping or renovating buildings. However, a few construction loans have recently been approved, mostly in the apartment sector and build-to-suit properties.

Are future interest rate increases a factor?

Interest rates have been very favorable for 12 to 24 months. Experts agree rates are going up, but not on when or by how much. Right now, it’s not a factor. Developers also aren’t saying, ‘I need to get this done now because I’m afraid rates will go up in the near term.’

Prudent lenders are sensitive to the fact that they’re underwriting deals at close to historically low rates. Good underwriters and credit officers are looking ahead and asking: If rates go up in three to five years, can the property absorb a higher interest rate when the loan is maturing?

Are there any other trends you’re seeing?

In the past two years, there’s been the return of other commercial real estate sources of financing, which is bringing liquidity to the table. Yes, it’s more competition for banks, but it’s a good thing overall because it’s a reflection of the market getting healthier.

Historically, life insurance companies, commercial mortgage-backed securities and banks have comprised about a third of the market each, which is what we’re beginning to return to. Previously, life insurance companies only looked at large scale deals ($10 million and up) in the office, retail and industrial space to put policy premiums to work. They’ve now moved into lending on apartments and are financing smaller deals of less than $5 million.

New loan production offices, commercial lending offices of out-of-state banks, also have opened, adding to the field of lenders.

How else is lending different today?

In the 2008-2012 period, developers and investors able to retain cash and not be heavily leveraged were in demand. That’s easing as borrowers that are reasonably leveraged, yet not extraordinarily liquid, are able to get projects financed.

On the lender’s side, underwriting today requires more in-depth understanding of global portfolios. Beyond the property in question, does the developer have other problem assets that could threaten the entire portfolio? The process is more information intensive, looking at the big picture details, understanding global cash flows and other factors. Developers know they need to come forward with a more detailed package — historical information on the property and a global presentation of their broader portfolio — which ultimately helps create more successful underwriting for everyone.

Michael K. Dostal is a senior vice president and North Coast manager of commercial real estate lending at FirstMerit Bank. Reach him at (216) 694-5654 or [email protected].

Stewart J. Rea is a senior vice president at FirstMerit Bank. Reach him at (330) 384-7170 or [email protected].

Insights Banking & Finance is brought to you by FirstMerit Bank