With so many lenders vying for commercial real estate transactions, commercial banks have had to become more flexible and offer financing structures that match their rivals.
KeyBank, for example, offers financing formulas similar to those offered by private equity firms and life insurance companies. This includes on- and off-balance sheet products, according to Andrew Lucca, executive vice president of KeyBank Real Estate Capital.
In addition, he often makes agreements with these shops according to the needs of their customers.
Investors are pouring money into real estate as a hedge against inflation and an alternative to low bond yields. Meanwhile, other investors are looking to cash in before interest rates rise under pressure. Commercial banks are ready and willing to finance a fair share of these transactions.
“There’s a lot of capital and a lot of motivated sellers,” said Gregg Gerken, executive vice president and head of commercial real estate at TD Bank. “Everything is for sale at the right price across the range.”
The struggle for market share
Banks face fierce competition at a time when CBRE forecasts a 10% year-over-year increase in commercial real estate investment in 2022.
“We are seeing an avalanche of capital entering the market from US and global institutional investors, private equity funds and insurance companies,” noted Michael Riccio, senior managing director of debt and structured finance at CBRE.
This means growing competition for banks from investment banks, private equity firms and insurance companies.
The availability of capital and the search for yield have become so arduous, Gerken noted, that debt funds are now willing to take a lower yield to win business.
“Their spreads were 400 basis points, and now they’re down to between 150 and 200 basis points,” he said.
CBRE’s Q4 2021 survey offers insight into the evolution of market share in the commercial real estate lending market.
The survey, an analysis of CBRE’s total issuance count, found that banks were the second most active lending group during the fourth quarter, increasing their share of non-agency lending volume to 29% from 24 .5% the previous year. Bridge loans accounted for 38.5% of banks’ loan volume, while permanent loans accounted for 35% and construction loans 21%.
Alternative lenders such as debt funds and mortgage REITs held the largest share of non-agency loan closings in the fourth quarter of 2021 at 37.7%.
Life insurance companies’ share of commercial mortgage closings fell to 14.8% in the fourth quarter from 20.2% in the third quarter of 2021.
CMBS issuance represented 18.5% of total loans in the fourth quarter of 2021, compared to 10.5% in the same period last year.
Fuel for growth
What are the drivers that will continue to fuel commercial real estate lending this year? According to Lucca, you can expect to see more acquisition activity as sellers worry about the economy and asset values.
“People are realizing they could get the best value if they sell now because valuations are at all-time highs and interest rates are still low,” he explained.
The most active sectors for commercial banks – and for investors – will continue to be industrial and multi-family due to strong demand and income growth.
“We see no signs of a slowdown in these two favored asset classes,” noted Al Brooks, head of commercial real estate for JPMorgan Chase.
The value equation for investors in these types of properties has helped thwart large moves in cap rates.
“It’s like a tale of two cities,” Riccio said. “On the institutional side, there has been no change in capitalization rates. But for small equity trades under $10 million that typically use more debt as leverage, borrowing rates are a bit higher.
Refinances should also become increasingly popular as investors race to outpace the rise in the yield curve, Lucca predicts.
Construction finance, however, is an area where bankers remain cautious due to inherent risks such as labor shortages, supply chain disruptions and the rising cost of building materials. .
“Construction financings are also expected to be more challenging this year as floating rate indices rise as the fed funds rate continues to climb,” noted CBRE’s Riccio.
At KeyBank, they hedge their risk in this lending category. “We limit the amount of development we fund and make sure costs are locked in upfront due to inflation and supply issues,” Lucca revealed.
Some banks, on the other hand, continue to actively seek construction loans. Bank OZK, the regional powerhouse in Little Rock, Ark., was one of the most ambitious construction lenders last year, and it doesn’t seem to be slowing down.
Among its construction loans this year are a $540 million loan with Carlyle Group for a 1,000 square foot mixed-use project on New York’s Fifth Avenue and $800 million for a condo tower in New York City. Upper West Side in February; and a $236 million loan for an office development in Dallas in April. (The bank also signed a 110,029 square foot lease for a new regional headquarters in the Dallas property building.)
During Bank OZK’s fourth quarter earnings call, Chairman and CEO George Gleason said the bank sees the opportunity to make its biggest loans yet by lending on several of the complex mixed-use projects. who will seek funding in 2022 and 2023.
It remains to be seen whether those estimates will be adjusted in the bank’s first quarter 2022 earnings call.
Redevelopment and non-development
One potential area of increased activity for banks and other lenders is office redevelopment. Businesses need state-of-the-art amenities to attract employees to the workplace, and landlords need their buildings to stay relevant. Features sought by tenants include better indoor air filtration, fitness centers, outdoor spaces, private terraces and shared rooftops.
“This became a noticeable trend in the fourth quarter of last year and will continue through 2022,” said Steven Durels, executive vice president and chief leasing and real estate officer at SL Green Realty Corp. “And that doesn’t just happen in Class A office buildings, but also in Class B buildings that are close to public transit.”
In March, SL Green announced that IBM would consolidate nine New York offices into One Madison Ave. upgraded in the Flatiron neighborhood of Manhattan.
SL Green funded the $1.25 billion redevelopment just before the pandemic hit with a facility led by Wells FargoTD Bank, Goldman Sachs, Bank of America and Axios Bank.