Western Real Estate Business

JUL 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

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www.REBusinessOnline.com Western Real Estate Business • July 2018 • 23 RISING RATES HAVEN'T SLOWED CRE LENDERS Chatter about the impact from rising interest rates may remain strong, but that hasn't stopped many of the West's key players from getting deals done. By Nellie Day I nterest rates that continue to creep up have not had a major impact on the West's lending activity, and this is primarily due to perspective. This is, after all, still considered a low-rate environment, though the likelihood of rates climbing ever higher has compelled many commercial real es- tate players to take action now while terms appear favorable. "We have seen a move from some sponsors to refi- nance early into long-term debt in order to lock in the attractive rates, with the view that we are still in a low-rate en- vironment histori- cally," says Kevin MacKenzie, execu- tive managing director at HFF's New- port Beach, Calif., office. "On most immediate borrowing needs, we gen- erally see the majority of borrowers compelled to rate lock as quickly as possible now in fear of rates continu- ing to run." Financing from banks seems to have fallen a bit, accord- ing to Peter Norrie, managing director in Cohen Finan- cial's (a division of SunTrust Bank) Portland, Ore., of- fice, but this doesn't mean overall lend- ing activity is down. In fact, the introduction of new pro- grams and lending sources has al- lowed the market to remain robust as more options mean more deal cover- age. "Rising rates have not had a signifi- cant impact on lending so far in 2018," Norrie says. "Financing volume has met expectations overall, however, volume from bank financing has fall- en off from 2017. Agency, life com- pany and CMBS underwriting has not changed from 2017, with agency and life company lenders offering new programs in 2018. Deal volume for 2018 should be consistent with 2017." Players may be acting quickly to lock in rates and secure favorable terms, but that doesn't mean rising in- terest rates haven't had any impact on Western deals. "Rising interest rates have curbed the investment sales market for sta- bilized assets where properties were already selling at historically low cap rates," says Robert Slatt, principal at Newmark Realty Capital in San Fran- cisco. "Alternatively, with rising inter- est rates, we have seen lender spreads compress for stabi- lized, lower-lever- age loan requests across the board. For Class A and B prop- erties with perma- nent loan requests below 65 percent loan-to-value, we are still seeing a bor- rower's market with very competitive interest rates." With a mitigated impact from rising interest rates, it's no surprise that un- derwriting terms have also remained steady. Many view this stability as a positive market attribute that may keep us out of a potential recession situation a la 2008. "Underwriting terms have not materially changed for us at CIT and most regulated banks seem to be maintaining strong credit param- eters," says Bryan Cavalier, manag- ing director and West Coast head of real estate finance at CIT Groups in Los Angeles. "Real estate bank loan leverage has remained relatively conservative during this cycle and we have not seen material degrada- tion of credit structures. I do not see banks lending more than 65 percent to 70 percent LTV, whereas you saw some 80 percent LTV loans 10 years ago. The disciplined credit approach, combined with healthy bank capi- tal ratios, should position banks to weather any real estate downturn much better than during the last re- cession." Popular Products As expected, many lenders are still bullish on multifamily out West. The threat of higher interest rates has im- pacted the single-family housing in- dustry, with the Mortgage Bankers Association reporting that mortgage application volume was down 4.5 per- cent compared to a year ago. Zillow also noted that the share of median income needed for a monthly mort- gage payment on a median U.S. home increased to 17.1 percent in June. This represented the largest share of in- come since 2009. Half of the U.S. metros noted for spending the largest percentage of the area's median income on housing are based out West. The list is topped with San Francisco/San Jose, Calif., where 51.2 percent of the median income is spent on housing. This is followed by Sacramento, Calif. (2), Portland, Ore. (4), Denver (5) and Phoenix (6). Though multifamily may remain popular, the ration of income to hous- ing costs make Brian Good, CEO of iBorrow in Los Angeles, a bit nervous about just how long many residents can continue to spend more than 50 percent of their income on rent or mortgages. "Our approach to underwriting loans is based on the cost basis of a property that determines the outcome for the in- vestor and the lend- er," he says. "Cer- tain property types, such as multifamily, provide us the great- est comfort in the current environment. We pay close at- tention to the income ratios that land- lords are approving for apartment tenants, however. As an example, tra- ditionally, rents could not exceed 30 percent of a tenant's income. Now it is closer to 50 percent. The loosening of these standards may not bode well for multifamily landlords in softer mar- kets." A slowdown in construction for pricey, Class A multifamily prod- ucts may prevent this problem from spiraling out of control in some sub- markets, particularly ones that are already saturated with elite housing options where affordability is obso- lete. "Apartment rental demand remains quite strong, with only a few submar- kets where we are concerned about excess Class A sup- ply," Cavalier notes. "We have seen less Class A construction loan opportunities in 2018, perhaps giv- en moderating rent growth assump- tions and the spike in construction and labor costs making new projects harder to pencil." A rise in ecommerce and a well-con- nected infrastructure system have also made industrial a stand-out product of choice among lenders. "The industrial sector is hot on the West Coast," says Gary E. Mozer, principal and co-founder of George Smith Partners in Los Angeles. That same rise in ecommerce hasn't necessarily boded well for retail prop- erties, however, though Mozer notes there are still ways to get these deals done. "The retail sector has become in- creasingly challenging because of the perception of the internet tak- ing over the world," he continues. "I have found opportunities in financ- ing strip centers, power centers and malls by focusing on the nuances of assets. A well-presented analysis of hot-button issues like co-tenancy provisions, an ecommerce-resistant tenant base and an understanding of local market dynamics can mean the difference between multiple lenders competing to win a deal and a 'no bid' situation." Cavalier agrees with this perspec- tive, noting there are always oppor- tunities in every product type, though market fundamentals and changing consumer preferences must always be considered. "Retail loans are tougher to get done given the volatile retail environment, but we will always consider well-lo- cated, well-occupied shopping cen- ters with strong sponsors," he says. Areas of Interest Many lenders remain generally op- timistic about the entire West Coast, though there are naturally a few stand-out areas. Mozer believes the West's coastal mar- kets will continue to be targeted by lend- ers, as will any infill projects. MacKenzie and his team are fo- cused on the West's core markets, which he believes will continue to attract the most aggressive balance sheet capital, though he does think secondary markets may offer some bright opportunities. Norrie agrees, noting that "all major markets in the West will remain attrac- tive to lenders. We may see some more activity in the smaller West markets as rents and cap rates remain extremely aggressive in the major cities." While challenges like rising interest rates, a shift in consumer tastes and larger economic issues will always play a role in the West's commercial real estate lending environment, Slatt and the rest of our experts remain con- fident this region can weather the cur- rent precipitation with little effect. "Our footprint covers the West Coast from Seattle to Phoenix, includ- ing Las Vegas and all of California," he notes. "We have seen these markets continue to have low unemployment and significant demand for housing, which should correlate into a healthy commercial real estate market. Our ex- pectation is that we will have another record year of loan originations, and I expect business as usual throughout the entire West Coast." n MacKenzie Norrie Slatt Good Cavalier Mozer

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