Environmental due diligence in the commercial real estate lending sector will take many shapes in 2012. Banks are under pressure by regulators to minimize their exposure to environmental risk in commercial real estate lending practices. Asset dispositions by lenders to clear their balance sheets of distressed loans and properties are on the rise. On top of that, a record-high wave of loan maturities is hitting the market this year and next. A massive transfer of commercial properties is underway and environmental due diligence will play a critical role in the process.
The most significant forces driving environmental due diligence for commercial real estate lenders this year are:
- Originations Are Up
A growing minority of large banks are starting to lend more, and following their lead, more regional and local banks are returning to the real estate sector as borrower interest increases. By far, the most growth has been with life insurance companies that have been aggressively growing their lending volumes in the downturn. Life insurers could allocate as much as $45 to $50 billion to commercial and multifamily real estate transactions in 2012. Stalled construction projects, including multifamily projects, in some areas are starting to breathe life again.
- Location Matters
On traditional commercial real estate deals, the metros where investors are the most active are also associated with the strongest demand for environmental due diligence. The hot spots being targeted by institutional investors (Austin, Los Angeles, San Francisco, New York and Boston) are among the fastest-growing markets for environmental site assessment activity. In general, due diligence activity to support property investment in 2012 will be concentrated in strong coastal metros, urban city centers, transit-oriented live/work locations and markets with solid job growth from tech, energy and health care.
- Loan Dispositions in Early Innings
Lenders’ sales of distressed loans will continue to be an active driver of due diligence, unleashing a new phase of distressed deals. The uptick in loan sales is due to a number of factors, including a realization by lenders that property prices may not rise in the near future. In addition, loan sales, in many cases, can be a quicker option than workouts or foreclosures. Lastly, stronger bank balance sheets that are in a better financial position to handle loan sales than in 2009 or 2010 will also contribute to a rise in loan sales this year. The willingness of banks to sell property loans is being met by enthusiasm on the part of investors, particularly private equity and hedge funds, to acquire them.
- Refi Heartache
Loan maturities will be a major driver for environmental due diligence in 2012 as a record $363 billion in maturing commercial real estate debt comes due. The volume of capital for refinancing these properties is expected to fall far short of what this volume of debt requires. Loans in need of refinancing will be challenged by high loan to value ratios, limited capital and underwriting that is much more stringent than when the loan was originated. As the market moves into the peak period for loan maturities, it will add up to a great deal of scrutiny, including environmental due diligence, as the collateral behind these loans changes hands. As such, the distressed market should be an active market for environmental due diligence—not just this year but for the next several years.
Environmental due diligence, like property appraisals, has a very important role to play this year in informing the process of estimating a property’s value as billions of dollars in property assets change hands.
For more intell on the factors driving due diligence in the lending sector in 2012, tune into EDR Insight’s February 22nd webinar, “Top 10 Trends in Commercial Lenders’ Due Diligence”.