Credit crunch goes commercial

Tuesday, February 12, 2008 at 2:30am

Credit markets continue to swoon and affect not only the residential mortgage industry but also commercial real estate.

The credit crunch has eliminated a major source of debt for developing or acquiring commercial real estate — commercial-mortgage backed securities. These are pools of loans with varying degrees of risk sold to investors.

According to industry trade newsletter Commercial Mortgage Alert, CMBS firms originated $332 billion in loans last year. This year it’s expected to be half that. Last month marked the first time in 18 years that not a single loan pool went to market.

“It’s dead this month,” said Mike Gorney, a principal with WexTrust Equity Partners in Nashville.

For Nashville, more developers may have to delay plans for new projects. Already, projects such as Signature Tower, Westin downtown and others have been delayed in part because of financing.

The crunch could mean lower sales prices for those selling their commercial property and possibly slower sales volume this year, real estate industry professionals say.

Tougher terms are affecting return on investment calculations. And, sellers may decide to wait out the storm and pull back from the market instead of taking lower prices, brokers said.

Tom Frye, managing director of CB Richard Ellis in Nashville and a former banker, said prices for commercial properties could drop as much as 25 percent because the buyers won’t be able to get the desired returns with higher equity requirements.

Gorney said it’s now back to basics “like the old days.” Buyers work with “balance-sheet lenders,” those that keep the loans on their own books instead of selling them in the pools, he said.

That means bringing more equity to the table and the 20 percent cash and 80 percent debt ratio becomes the norm again.

Commercial properties with assumable debt, good loan-to-value ratios could be prime buying targets. Frye said these may not require a lot of equity and could have a good rate if refinanced in 2005-2007.

“Those are the most valuable properties in the country,” Frye said.

The CMBS market got crushed basically by what was happening with the residential loan pools — laden with sub-prime mortgages — that were going bad. Frye noted that across the country residential delinquencies nearly doubled, rising from 800,000 at the beginning of 2006 to 1.5 million at the end of the year.

Meanwhile, delinquencies with the CMBS pools were three tenths of 1 percent, Frye said.

“It’s good paper,” he said. “There are a bunch of people out there who are going to be buying those CMBS pools at deep discounts.”

Real estate experts say that means more cash in the deal and collateral. Second mortgages, known as mezzanine debt, are probably not in the picture for a while.

“Mezzanine lending for all intents and purposes is dead,” Frye said.

Gorney and others said it’s probably not so bad that the commercial lending markets cooled.

“It’s good because the lending terms were getting out of control,” Frye said.

In particular, lenders were loaning 90 percent of the value or 10-year, no interest loans.

Debt rating agency Moody’s Investors Services sent a shot across the bow last April by in putting out that it would alter how it rated the debt, noting the increased aggressiveness in lending terms. That cooled the market some. But them the sub-prime piece hit, rippling through to the commercial side.

Developers got caught holding short-term debt when the bottom fell out of the credit markets last summer.

New York developer Harry Macklowe became a poster child for the commercial credit crunch. Macklowe is on the hook for more than $6 billion on seven New York City skyscrapers and trying to fend off foreclosure. He got stuck when credit tightened and he couldn’t get a long-term debt on the property.

Real estate developers and brokers had hoped the credit markets would begin to ease.

“No one knows how long it will take,” said Lance Patterson, president of Atlanta-based Barry Real Estate Cos., which is developing Pinnacle at Symphony Place in downtown Nashville.

Barry recently pulled in financing from former NBA star Magic Johnson’s Canyon-Johnson Urban Fund. The developer won’t need to look for permanent long-term financing for two years or so when the building is complete and leased up.

“Certainly we hope that the debt markets aren’t as challenging as they are today,” Patterson said.

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