November 19, 2017

Andy Little


by Andrew Little, Special Correspondent

Singer David Johansen, aka Buster Poindexter, probably wasn’t thinking about commercial real estate when he sang one of his biggest hits, “Hot, Hot, Hot.”

But the title to that hit song accurately describes the current state of the commercial real estate market. The ongoing strength in the sector can be attributed to cheap and available capital.

The conduit market, which was written off for dead two years ago, is poised to complete 2017 with the second-highest annual volume since the financial meltdown in 2008 and pricing that is close to post-recession lows.

In the past two months alone, pricing has fallen on benchmark AAA-rated commercial mortgage-backed securities spreads by close to 0.20 percent — a drop that was unthinkable in prior years. Perhaps more interesting is the AAA pricing has come down while the market has become less volatile.

The combination of falling spreads and less volatility has made conduit lending very profitable.

The irony is that fewer conduit players are active today than two years ago when the market was petering out. So, while volume and profits are soaring, fewer market players are sitting at the table. Admittedly, those at the table are competing fiercely for deals.

In addition to more conduit money fueling deals, more money is going into agency deals than in any prior year.

The production for Fannie Mae and Freddie Mac in 2017 is so strong that there is rumblings of huge cutbacks for 2018. The Federal Housing Finance Agency, which is charged with overseeing agency lending, has not made any announcements for 2018, but changes are expected.

Jerome Powell, nominated this month by President Donald Trump to be the new chairman of the Federal Reserve, is an outspoken advocate of reforming the two government-sponsored enterprises.

Powell, who has been a member of the Fed’s board since 2012, said in a speech earlier this year to the American Enterprise Institute that more private capital needs to be in play and that the next few years may present “our last best chance to finish critical reforms” and address systemic risk presented by the dominance of Fannie Mae and Freddie Mac in housing market finance.

Not that the Fed chairman has a great deal of power over the Federal Housing Finance Agency, but the agencies are on pace to provide close to 50 percent of all multifamily mortgages this year, according to industry estimates, which far surpasses their lofty goals of providing 40 percent of the multifamily mortgages.

So, what does all this loan production mean to commercial mortgage rates?

Rates are about where they were last month and are currently in the 3.50 percent to 3.90 percent range for 5- and 10-year loans offered by life insurance companies, according to the John B. Levy National Mortgage Survey.

Conduit pricing has come in dramatically and now averages 4.10 percent to 4.35 percent for higher leverage loans.

Banks are finding it more difficult to compete on both proceeds and price against non-recourse bridge lenders, particularly on loans larger than $20 million.

This can be attributed to the strength of an obscure portion of the lending world known as the collateralized loan obligation market. While that type of loan obligation was a popular pre-crisis source of capital, the market hasn’t been a viable alternative for commercial real estate lending until very recently when pricing and volatility dropped.

Groups now with relatively small amounts of capital can produce loans that are sold off to bond buyers at cheap yields. That allows these small and nimble firms to compete favorably against regulation-laden banks.

With leverage pushing 75 percent to 80 percent of costs, banks have a tough time competing. Pricing is in the 4.5 percent to 5.5 percent range, which is higher than most larger bank pricing, but attractive enough for many because the other great benefit is there are no personal guarantees.

While the overall commercial real estate market is “Hot, Hot, Hot,” there still appears to be runway before things slowdown, particularly in smaller markets like Richmond.

With conduit pricing coming in and volume ramping up, it would not be a surprise to see transaction activity pick up in the area.

More than $150 million of loans were originated by conduits in Richmond so far in 2017, according to Trepp, LLC, a New York-based provider of analytics and commercial real estate information.

The list of originations is chock full of hotels. Next year, it is likely that the list will be larger and include other property types.

John B. Levy & Co. partner and investment banker Andrew Little can be reached at