Here’s the good news on commercial real estate: Loan activity is reviving and credit standards are loosening, according to industry data and experts.
But the bad news is sobering: The comeback is trough-shaped, varies by sector and necessitates solid numbers on the part of borrowers to gain approval from lenders.
Nationally, the total value of commercial and industrial loans plummeted during 2009 and into 2010, but began trending upwards during 2011, says Mark Eppli, a professor of finance and Bell Chair in real estate at Marquette University. “Banks hit the bottom in 2010 and have started to be net lenders again. The trend is good if you are a borrower.”
During the brunt of the recession, lenders tightened loan standards, says Eppli. They took steps like more strictly defining operating income, or requiring a bigger down payment under a conservative loan-to-value ratio. Another change has been that financing that doesn’t require personal liability – so-called “non-recourse” loans – remain hard to get today, he adds.
But recent data from the Federal Reserve shows that nationally, banks have been easing standards for commercial and industrial loans to small firms, says Eppli. The percentage of banks reporting a tightening of standards peaked in late 2008, fell through 2009 and most of 2010, with the trend continuing in 2011.
“Overall, I think there will be some new infusion of capital coming into commercial real estate,” says Eppli. “Banks will continue to loosen standards a little bit, and get closer to normal, conservative underwriting.”
The ‘right’ projects see funding
Area bank executives say the right purchases can get funded, but tend to be “owner/occupier” deals rather than investor developments. “Owner/occupier real estate projects are, have and will continue to get financed without any problem, because they are financing it for their own use,” says Mike Daniels, president of Nicolet National Bank. “The investment-type projects are less prevalent.”
Tom Mangold, the Appleton market president for US Bank, says the bank experienced “robust” regional activity for commercial real estate loans in the fourth quarter of 2011. The activity, he adds, is centered on properties that are income producing and “stabilized,” a term that refers to the predictability of income from a property.
Borrowers should be ready to prove their ability to generate operating income from a site, but the money is there for the right projects, Mangold says.
“The borrowers have to be able to tell their story, and be able to back that up with their track record for performance,” he says.
In short, the market is moving, but not like in pre-recession days. For one thing, investors aren’t developing new strip malls or office complexes, says Wade Micoley, president of Micoley & Company Realtors. “‘Build it and they will come’ is not happening,” he says.
Activity also varies by sector, says Micoley. Stronger sectors include assisted living complexes as well as sales of existing apartment buildings and some construction of new apartments. Both sectors are benefitting from demographic and economic trends that have increased demand.
Another bright spot has been industrial properties, notes Mark Denis, an advisor with broker firm Grubb & Ellis | Pfefferle in Appleton. National research from Grubb & Ellis shows that 90 million square feet of industrial space was absorbed in 2011 after accounting for space that came on the market. This is an improvement over the positive 14 million square feet in 2010, is far better than the record negative 200 million square feet in 2009, and second only to the 100 million square feet of supply absorbed in 2005.
The firm notes that low completions of new buildings accelerated absorption of industrial space this year, but still concludes that demand grew in the sector.
Denis confirms the trends hold true in Northeast Wisconsin, where thriving hub companies such as Marinette Marine seem to be having a ripple effect. “We are selling buildings and filling buildings on the manufacturing and warehousing side of the marketplace,” says Denis.
Multi-family housing hot
Eppli also sees a mixed market, with sectors like multi-family housing complexes doing “crazy well.” National research also shows that commercial properties in major “gateway” cities and prime locations or “core assets” in major cities are doing well. Expect that trend with core assets to expand to smaller markets, says Eppli.
The overall economy also remains challenging. With predictions for growth in gross domestic product not bullish enough to drive sharp job growth, demand for new office space likely will be sluggish, says Eppli. Additionally, he adds, many banks across the country were too weak to take the loss on non-performing commercial real estate assets, but now that banks generally are stronger, they are shedding those assets, contributing to the supply of low-priced properties.
Micoley’s firm is involved in the auctioning of commercial properties and continues to see a backlog of foreclosed properties. Due to the lag time in foreclosure processes and in sales cycles for commercial properties, says Micoley, it’s likely the market will have to “grind through” this backlog for a long time. “In my estimation, we are in the middle of that grind-through process,” he says.
So even as the market slogs through this trough-shaped recovery hoping to find a steeper improvement curve, there are some small upsides. For instance, says Micoley, some businesses that have downsized while leasing may now be in position to buy an ideal smaller building at a great price.
Investors also need to put capital to work somewhere, notes Eppli, and with the bond market generating low returns and stocks volatile, investors will look anew at commercial real estate. “More and more (investors) are getting comfortable with real estate being the preferred, risk-adjusted asset to get into,” says Eppli.
Mangold notes that ultimately, banks also need to put money to work. “As we go into 2012, 2013 and 2014, banks will continue to come back to the (commercial real estate lending) market,” he says. “With consumer demand lower for home loans, and residential housing sluggish, banks will need to pursue commercial real estate lending.”