Turmoil in the market for residential mortgages is having profound ripple effects on commercial real estate, making it more difficult for buyers to finance their deals and presenting a rare opportunity for lenders that are willing to take on risk in a tenuous market.
The biggest recent shift in the financing of commercial properties is a dramatic decline in issuance of commercial-mortgage-backed securities, which, underwriters say, is down by more than 75 percent since August. Many CMBS investors have been suffering subprime and other credit market losses and are avoiding risk by not buying new issues. As a result, much of the capital for property transactions is now coming from syndicated loans, which had fallen out of favor in recent years because of the more favorable pricing that was available in the CMBS market.
A number of recent deals that typically would have been financed with CMBS have instead gone to the syndicated loan market, including the more than $1 billion mortgage on 388-390 Greenwich Street in New York. An SL Green Realty Corp. partnership recently bought the Lower Manhattan trophy from Citigroup for more than $1.6 billion and turned to PB Capital Corp. and Westdeutsche ImmobilienBank to fund the loan. Additionally, Merrill Lynch & Co. and its partners decided to syndicate a loan on a portfolio of hotels owned by Blackstone Group rather than securitize the debt.
Despite the welcome uptick in business, some arrangers of syndicated commercial mortgage loans are taking steps to avoid assuming too much risk. Increasingly, they will not commit to lend a specific amount to a borrower before meeting with potential syndicate members to find out how much of the loan these institutions will buy. That’s a twist on the conventional practice of making a big loan and subsequently trying to sell chunks of it to other banks. So-called club deals, which typically involve loans of more than $100 million, help lenders minimize the risk that they might be left holding more of a loan than they originally intended.
“Banks won’t close on a deal and take syndication risk,” says David Rosenberg, a managing director at New York–based mortgage brokerage firm Meridian Capital Group.
Bank of New York Mellon recently employed a club structure on its $700 million syndication of a construction loan for a partnership between Twining Properties, MacFarlane Partners and Related Cos. to build a giant development at 440 West 42nd Street in New York. The bank, according to several lenders familiar with the transaction, lined up more than 30 syndicate members to take $15 million to $20 million pieces of the loan, which will be used to build a 56-story, mixed-use high-rise near the planned extension of the No. 7 subway line.
The shift to syndicated lending and club deals is happening primarily because banks are afraid to take on big credit risks. “There is no underwriting market out there of substance,” says Matthew Galligan, head of U.S. property finance at Bank of Ireland.
The reemergence of syndicated lenders — often called balance-sheet or portfolio lenders because they retain a sizable portion of the mortgage on their books — is reminiscent of the financing market in the late 1990s, when the CMBS market was still getting off the ground. Ironically, one of the developments that fueled the growth of the CMBS market was the credit crunch of 2002–’03, when syndicated lenders backed away from doing deals following a wave of corporate credit losses. Portfolio lending is dominated by big banks and insurance companies, whereas investment banks hold sway over CMBS.
“In a way, things have come full circle,” explains Annemarie DiCola, CEO of New York–based Trepp, a commercial real estate analytics firm. “When you go back ten years, the key source of financing for the commercial real estate market was the portfolio lenders and the balance-sheet lenders. We are now into a situation where balance-sheet lenders and traditional portfolio lenders are back at the top of the lending chain, at least for now.”
Many real estate financiers believe that CMBS eventually will reemerge as a key source of financing for property transactions, but it’s unclear when that will happen. What’s certain is that even with portfolio lenders taking up the slack, commercial mortgage credit is becoming less available. And that will likely have a negative effect on property values, just as the subprime blowup has hurt home prices.