It’s a good time to be a commercial real estate borrower if you have performing property. Low market interest rates help solve underwriting problems if buildings have lower leasing rates or occupancy levels than lenders might like. Also, the banks with excess liquidity are competing for business and offering more aggressive terms and skinnier pricing.
“Back in 2009, 2010 and 2011, only a handful of banks were making commercial real estate loans,” says Rig Goss, vice president of Commercial Real Estate at First Federal Lakewood. “But since then most banks are back in the game. It has gotten competitive again.”
Smart Business spoke with Goss about the recent activity and how to leverage the commercial real estate lending climate.
How has Cleveland’s commercial real estate industry been performing?
It was a good year, but some areas and products did better than others. Downtown was the big winner with large new projects coming online. The 2016 Republican National Convention also has spurred the development of over 1,300 hotel rooms.
Like many cities, Cleveland is experiencing a reverse urban sprawl and people, especially millennials, are moving back downtown to live, work and play in the same area. Downtown residency rose 60 percent in the past five years, and that’s predicted to double to as many as 25,000 residents by 2022. New downtown apartments have been developed from empty office space in Class B and C buildings, which has helped reduce office space vacancy from 23 to 18.6 percent.
Other pockets enjoying a building boom are University Circle and Crocker Park.
Otherwise, new construction in Greater Cleveland remains slow. Despite a growing economy, jobs and population growth drive real estate development; Cleveland isn’t enjoying the same increases in those areas as other markets.
Land acquisition and development loans for both commercial and residential properties have been nonexistent for five years, and developers who survived the recession, with a few exceptions, haven’t had activity reach prerecession levels.
What about current lending conditions?
It’s a green light for most lenders, with fairly normal underwriting standards — around 75 percent loan-to-value ratios on most commercial buildings. Lenders will go up to 80 percent loan-to-value ratios for apartments and owner-occupied buildings. Another standard covenant is 1.20 to 1.25 debt service coverage requirements on loans, meaning the property’s net operating income needs to be 1.2 times the annual debt service payment. Projects with low loan-to-value ratios and financially strong borrowers may be able to secure limited or non-recourse loans.
What’s the latest on rising interest rates?
Interest rates are going up, but it’s anybody’s guess when. Many thought rates would rise in 2015 due to domestic economic growth, the Federal Reserve’s curtailment of quantitative easing and an anticipated hike in the Federal funds rate. However, the outlook for key global markets like Europe, China and Russia could lead to slow demand, a slow global economy and a prolonged period of low interest rates.
The 10-year treasury rate is around 1.8 percent. Even if rates rose to 3.8 or 4.8 percent, that is still historically low.
How can developers or owners help improve their odds of success?
The two factors that help all projects — interest rates and economic health — are beyond their control, but they can:
- Get as much preleasing in place as possible and extend existing property leases for development loans.
- Pay down existing debt and put equity into the buildings.
- Take advantage of private/public partnerships. The big downtown projects got done through huge capital stacks and multiple layers of financing with grants, economic development loans, historic and new market tax credits, etc.
- Use products like interest rate swaps to manage interest rate risk.
Be creative. If a project doesn’t have enough leasing or income to support the whole loan amount, structure a loan with an earn-out. This is where a lender funds a floor loan based on the income in place, and as new tenants sign, the bank allows additional loan dollars to be borrowed.
Insights Banking & Finance is brought to you by First Federal Lakewood
