Like many other markets these days, the commercial real estate market is struggling. Plain and simple, there is a lack of financing for commercial real estate projects.
According to Jeffrey M. Bloom, executive vice president and national real estate manager for Comerica Bank, a big reason for this is that the commercial mortgage-backed securities (CMBS) market was a huge component of liquidity in the marketplace, and over the last 18 months, that liquidity has pretty much disappeared.
“There were somewhere between $400 and $500 billion of CMBS loans generated in 2007,” says Bloom. “There are essentially none being generated today.”
Due to the economic climate, commercial real estate loan portfolios are more stressed than they’ve been in a long time, so portfolio lenders aren’t in a position to fill the void created by the lack of CMBS offerings. Commercial banks and life insurance companies, in particular are somewhat reluctant to generate new commercial real estate loans unless they are very well structured.
“Now you have a double whammy,” says Bloom. “There’s no liquidity from Wall Street and portfolio lenders are reticent to make commercial real estate loans because of the instability in the marketplace.”
Smart Business spoke with Bloom about the state of commercial real estate finance and why now more than ever your current lender is your best lender.
What is the most important thing businesses should know about the current commercial real estate market?
Besides all the liquidity problems, the lenders that are lending are being very selective and they’re playing with a new set of rules. By a new set of rules, I mean that lenders want lower loan-to-values, they want to lend on better projects, and they want higher debt service coverages. Lenders are now able to cherry-pick the assets they want to finance. Therefore, if you have a loan that’s maturing, your best option is your existing lender. Your existing lender doesn’t want to own the real estate, so it will be willing to work with you. However, your lender might require an updated appraisal, a remargin of the loan, a principal pay down, an increased interest rate and/or an increased guarantee structure. That may seem like a lot to give up, but it’s better than having a default.
So if your loan is maturing, what should you do?
Borrowers should be very proactive. Go to your lender and propose something that will buy you the greatest amount of time for the least amount of cost. Negotiations like this need to be taking place right now. Work with your lender to determine how much of a pay down you’ll need, how much your pricing is going to increase and what kind of principal amortization will be required. Do what you can to get yourself a favorable outcome, but remember: the negotiation has to be somewhat of a win-win. Your existing lender certainly wants to be better off tomorrow than it is today.
How can a company prepare for this negotiation process?
You have to know what your lender will be willing to do and under what terms. Make sure you’ll be able to fulfill everything that is going to be requested. And, be sure you know what your lender is going to ask of you, what its criteria are and how your needs will fit into that.
First of all, go in knowing that you’re likely going to have to make a principal reduction to the loan amount. Expect to pay a higher rate and, if the loan was a construction loan that wasn’t amortized, expect to pay amortization. If you can do those things, your lender will likely be more than happy to extend your loan, giving you anywhere between two and five years, depending on what the concessions are.
And as we all know, time is money, especially in this situation. There’s no expectation that the credit markets will open up any time soon, so you can’t anticipate that six to 12 months will be enough time to turn things around. The more time you get, the safer you’ll be.
What are the consequences of not renegotiating with your current lender?
No one knows what the future will hold. Your lender could face any number of external circumstances in the future that could affect its willingness to work with you. You don’t know what your lender will be willing to do down the road, but you can determine what your lender is willing and able to do today, so you should take advantage of that. There is so much uncertainty out there that once you have an agreed upon deal you should get it closed as quickly as possible. The certainty of execution is really important these days. As stated before, your best lender is your current lender, and this has never been more true than it is today.