THE COMMERCIAL FINANCING MARKET

Mike Moloney, President, Commercial Real Estate Institute, Inc.

                                                                

In general, commercial real estate “follows” residential. First, homes get built, THEN you get a shopping center, for example.

But, financing commercial real estate is completely different from residential.

1.) For example, with the exception of some ‘owner-occupant” loans, such as SBA, the down payments normally range from 30% to 45%. Commercial lenders on the whole are quite conservative. Portfolio lenders, banks, and specialty lenders that fund loans with their own capital, are dominating the commercial lending market.  Since they hold loans until maturity, they have avoided the capital markets turmoil.  The  “secondary market” provided by Wall Street investment bankers no longer “trusts” the loan originators and rating agencies to assure the credit quality of the mortgage-backed bonds. The due diligence performed by portfolio lenders that offer commercial loans is extremely lengthy, complex, time consuming, and expensive. The likelihood of “bad” loans being made is very remote.

2.) In addition, when the government regulators (federal and state) saw that residential real estate was slowing down, over a year ago, they tightened up the underwriting for commercial loans. The adjustment has already been made.

3.) Small investors were buying houses on speculation. Almost nobody buys a commercial property expecting to “flip” it in less than 5 years. Thus, the market is not susceptible to volatility, like the residential market, where any middle class person with decent credit could buy another home with less than 10% down. There has not been a speculative commercial investment market at all.

4.) If it won’t cash flow with 30% down, no one will buy a commercial property (unless their own business will use it – “owner-occupant” loan.) Even “owner- occupant” loans are not speculative. Most business owners don’t buy a building for their company until the company is generating so much profit that they need the tax shelter of owning. Tax shelter is the #1 reason why anyone buys a commercial property – and that means that they have excess discretionary income.

5.) Commercial real estate reflects the underlying economy, which is very strong.

6.) The real estate market usually benefits when the “securities” market stumbles. Investors then look for a more stable place to invest their money: real estate.

7.) The fundamentals of residential real estate are still strong, and it will “recover” before the end of 2008. People who want to work can find well paying jobs. Young people still want to have kids and a home in which to raise them. Jobs and population are still growing.

The residential “subprime loan crisis” was actually caused by investment banks issuing a new type of “security”: a type of “bond” that looked very secure to investors. The money generated from issuing those “bonds” (sometimes called Collateralized Debt Obligations”) was used to fund mortgage brokers to make subprime loans. That money was mismanaged. As we now know, nobody had any interest is making sure the loans were being made to people who could actually make the payments.

There may be possible future bad news, though. For the first time in history the same investment banks are now creating a similar type of “security” vehicle, that is, CDOs for commercial real estate. Assuredly they won’t use the same name for these new “bonds”. If they mismanage the commercial investor money like they did the residential, and flood the commercial real estate market with “easy money”, commercial real estate could be in for trouble a few years from now.

In summary: commercial real estate is strong and stable. For now, it will become risky only if “easy money” gets into financing commercial property, and unseasoned speculative investors, such as those bailing out of the “stock” market, start over leveraging commercial purchases. There may be a slight “copycat hiccup” in commercial financing until the end of 2007, but, if so, it is not likely to be long lasting, nor severe.