I attended the Real Estate Capital Markets Conference held at the Golden Valley Country Club on Thursday, April 30, 2015. Main topics included The State of the United States Banking System, Financing Solutions for Real Estate Investors and Real Estate Equity Investors Requirements and Investment Deal Flow. Below are several highlights from the event.
State of the United States Banking System
Three panel members from the banking community took turns sharing thoughts on the lending environment surrounding commercial real estate. The speakers were from U.S. Bank, Bremer Bank and Bridgewater Bank.
According to the lender from U.S. Bank, the top 10 banks in the United States have pretty well recovered from the downturn that impacted all lenders starting in 2008 and extended into 2012. Lenders saw increased lending opportunities beginning in early 2013 and 2014 proved to be an even stronger year. The optimism continues as large banks are active in Commercial Real Estate (CRE) with plans to continue throughout 2015. Lending on speculative buildings has ramped up with strong sponsorships of the spec projects being a critical component to fund deals.
Within the Minneapolis/St. Paul metropolitan area, several large national banks such as Bank of America, PNC, SunTrust Bank exited the market during the last market downturn and have now returned. This adds to the competitive lending environment. This is positive for borrowers due to more lending options and more competition to provide the very best financing terms. Additionally, loan limits have increased with appetite to accept larger risk. Overall, big banks are very positive about CRE at the present time.
The lender from Bridgewater Bank indicated the Federal Reserve reported 2014 is when Minnesota banks returned to “normal.” Banks started to ramp up lending in 2013 and 95% of banks saw a profit in 2014. This has been helped by a reduction in problem assets.
Increased Regulation
A consistent theme among all lenders is regulations stemming from Dodd-Frank Act and other mandated guidelines have increased significantly over the past several years. The Dodd-Frank guidelines are still being implemented and will continue to roll out through 2020. The cost to comply with regulations and scrutiny is significant, particularly for smaller banks. Bankers now spend considerable time on regulatory requirements.
Another significant component of the regulations is the impact of Basel III rules that were adopted in July 2013. As part of Basel III, U.S. bank regulators implemented HIGH VOLATILITY COMMERCIAL REAL ESTATE (HVCRE) on January 1, 2015. As a general rule, a lender applies a 100% risk weighting to all corporate exposures, including bonds and loans. There are numerous exceptions to that rule and the one that impacts CRE is HVCRE. Simply put, acquisition, development and construction loans are viewed as a more risky subset of commercial real estate loans and are assigned a risk weighting of 150%. All three panel members cited the added difficulty with HVCRE and believe it is going to have a ripple effect on new construction projects.
HVCRE was defined as all acquisition, development and construction (ADC) commercial real estate loans except:
1) One- to- four family residential ADC loans; or
2) Commercial real estate ADC loans that:
- a) meet applicable regulatory LTV requirements;
- b) the borrower has contributed cash to the project of at least 15 percent of the real estate’s “appraised as completed” value prior to the advancement of funds by the bank; and
- c) the borrower contributed capital is contractually required to remain in the project until the credit facility is converted to permanent financing, sold or paid in full.
According to the speakers representing the various banks, the greatest impact is the 15% cash contribution requirement of developer. For additional Frequently Asked Questions about HVCRE, click here: http://www.cwrea.com/experts-corner/
Financing Solutions for RE investors
At present time, an unprecedented amount of capital is available and interested in investing in CRE. Real estate continues to be a sought after asset class as values in the U.S. are attractive relative to other regions and countries. This is attributable to fundamentals that continue to improve with the economy across property types and cap rates return to pre-recession levels. According to Doug Seylar, Managing Director for Minneapolis CBRE Capital Markets Debt and Structured Finance, a few key factors are as follows.
Institutional capital has a strong appetite for real estate investment due to:
- The yield on traditional fixed income instruments remains at historical lows
- Demand for core continues strong and expanding, searching for yield broadens definition of “core”
- Development activity increasing
Foreign capital flows into the U.S. are significant and have moved beyond traditional gateway markets and core focus.
The CMBS market share is growing after several down years. These lenders are looking for stabilized assets and offer non-recourse loans with no personal liability.
A lot of institutional money is flowing to the Midwest due to economy strength in Minneapolis/St. Paul and this is driving down cap rates. Increasingly, out of state and country capital is seen as often being willing to overpay because they need to deploy capital.
From the life insurance company perspective, these lenders offer longer term money and are a good option for someone looking for longer fixed rate terms. The constraints are greater proceeds required up front with typical LTV ratios of 65% to 70%. Opinions on the future of interest rates are mixed (will they rise or remain stable). However, some consensus is that spreads will likely compress due to competition.
How does a borrower find an opportunity in the current environment? It can be challenging to compete as a local developer/builder with institutional money acquiring projects such as Walgreens or new construction apartments counting on high sustained rents over the long term. A better chance/opportunity for better return is for value-add investments. An alternative option one could weigh is selling a 1031 investment, holding the cash and waiting for a downturn.
Real Estate Investor Trends
It was reported $41.2 billion came into the U.S. in 2014 for investing in CRE. With more capital flowing into the market and increased number of investors focused on preservation of capital, cap rates are lower. According to one panel member who recently returned from a national conference, a lot of people see this continuing for 18-24 months. As the development cycle extends, more suburban development is occurring.
Where are the opportunities?
A national investor focusing on industrial properties cited the following factors are desired for finding quality investments.
- Properties at or below replacement cost
- Good credit tenant
- Great location
- Good functional utility
In the Minneapolis/St. Paul metro area, opportunities exist in finding a property with a good story, good location and some upside potential such as ability to improve management and lower expenses, etc. This makes it easier to attract outside capital.
Thank you for taking the time to read this article. Mitchell Simonson, MAI is an expert commercial real estate appraiser and investor. If you have any valuation questions, please feel free to call at 612-618-3726 or email [email protected].
Best Regards,
Mitchell Simonson, MAI