“More of the Same” for Commercial Real Estate Lending, Tight Underwriting in 2013

The latest quarter’s financial results from financial institutions show continued growth in commercial lending, albeit at a slower pace than previous quarters. The forecast will likely remain slow growth with heightened risk awareness.

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Current Loan Volume Struggles to Gain Traction…

As shown in the accompanying graph, which excludes the largest 25 banks in the country, commercial and industrial loan portfolios at small and midsize banks (shown by the lighter bars) have been growing fairly steadily since March—despite a slow August, and an increase of nearly 10 percent in the third quarter. In contrast, commercial real estate loans (denoted by the darker bars) have struggled to show any marked improvement. Demand for commercial real estate loans is still weak, as for many other types of loans, consistent with the slow recovery in the overall economy this year, and in the third quarter in particular. Interest in multifamily rental properties, in particular, is largely driving any positive movements in overall volume. For many banks, multifamily lending continues to be the largest growth category or strongest growth category in its loan originations portfolio. Although there has been a slight uptick in loan demand for office and retail properties, market fears are making investors less aggressive than they had been earlier this year in pursuing commercial real estate deals in sectors other than multifamily. The ongoing economic sluggishness and the European debt crisis still loom, the political rhetoric over banks’ reputations is likely to heat up as the presidential election approaches, and the fallout from some of the summer’s scandals is unlikely to disappear anytime soon.

Trends in the volume of commercial real estate lending also vary considerably from bank to bank. Many larger institutions are still focused on unloading distressed loans from their balance sheets and liquidating foreclosed real estate, while others are aggressively staking a claim in the commercial real estate lending space.

…Future Likely to Bring “More of the Same”

Just a few weeks ago, PwC released its highly-anticipated Emerging Trends in Real Estate report for 2013. Based on input from more than 900 leaders in the real estate industry, the report includes PwC’s forecast for real estate capital markets. Findings with relevance to the commercial real estate lending industry, and environmental due diligence, in particular, include:

  • Lenders continue to hold onto a “slew of underperforming loans in a glacial deleveraging” while prices creep up slowly.
  • Much of the lending activity is focused on the dominant 24-hour cities and a handful of tech and energy regions.
  • Good assets with solid income streams and borrowers with sterling credit will have no trouble securing financing from banks.
  • Borrowers with bad credit or marginal assets most of all “get the cold-shoulder treatment or, more likely, receive an extend-and-pretend pass.”
  • The estimated $300 billion of refinancing required for maturing loans over each of the next three years will decrease lenders’ ability to write new commercial mortgages and force a continuation of extend-and-pretend strategies on existing debt. (Expect more of the same for another year at least.)

Stringent Underwriting Here to Stay for Near-Term

On the underwriting front, the report predicts that today’s stringent underwriting will “harden into practice in 2013”:

• On the debt side, nearly 40 percent say loan terms will become even more rigorous in 2013. (Exhibit 2-3).
• On the equity side, this percentage falls to nearly 30 percent (Exhibit 2-4).

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Refinancing continues to be a drag on the loan origination market. The community of active lenders is smaller and future consolidation is certain, especially as new banking regulations put added pressure on the remaining players. The lenders who remain will continue to focus on dealing with the $300 billion in loans maturing annually through 2015, and the borrowers who need capital will face tough underwriting standards, pressure on due diligence and in many cases, the need to bring more capital to the table. What continues to help the property transaction market, however, is that real estate that is properly underwritten, especially in a low interest rate environment, remains an attractive place to invest capital in an uncertain market. And that is what will drive only growth—albeit modest growth—in 2013.