In the last three years, there has been a transformation of the commercial real estate lending industry from top to bottom.
Mergers, acquisitions, and consolidations stemming from deregulation have allowed companies a chance to offer a wider range of products and services and broader geographic coverage. This lateral and vertical integration is allowing companies to offer "one-stop shopping" to customers with lower fees and quicker response time.
Simultaneously, we are seeing new life from the traditional market players. Life companies, pension funds, Freddie Mac, and Fannie Mae are becoming more aggressive and active in the commercial lending marketplace, competing head on with Wall Street in pricing and products.
Conduits, which continue to play a much larger role in shaping the lending industry, now represent 50% of commercial mortgage-backed securities issuance, up from 5% in 1992. They are expected to close $60 billion plus in loans in 1998, up from $44 billion in 1997. To remain competitive, lenders must focus internally on process and efficiency, as well as externally on relationships, products, and service.
When it comes to relationships, the industry is moving toward a "franchise" system where originators, lenders, and services are being rated, which is spurring relationships among high-credit institutions. While investment banking relationships are critical for public/private execution and subscriptions, origination and servicing relationships are equally important.
Establishing a broker or a direct program can be a pricing/service trade-off. Broker programs focus primarily on incentives and competitive pricing, where customer service is less relevant (often brokers receive a half-point fee, while the lender is funding the transaction at par and minimizing pass-throughs).
Direct programs are more resource-incentive, but receive better transaction pricing (often a point to a point and a half, and pass most or all third-party costs through to the borrower). The keys to these programs are geographic coverage and strong customer relations to establish repeat business.
Servicers, special servicers, and asset managers are also equally important for securitization pricing as well as maintaining borrower relationships. The rating agencies have long acknowledged that highly rated servicers and special servicers are critical to achieve high credit ratings, and investors have echoed these sentiments in their pricing.
More lenders are venturing into new product types, expanded property types, and higher leveraged programs, while relaxing current lending requirements.
More lenders are starting up or becoming more aggressive in mezzanine, bridge, construction/perm, and equity programs. Conventional loans are feeling the brunt of the tightening of the market as loan-to-value and debt coverage requirements are inching lower.
Conduit benchmarks for debt coverage ratios have thinned to 1.20 times and 80% loan to values. Smaller book lenders have begun pushing high-loan- to-value programs with 90% to 100% first mortgages with 1.10 times coverage ratios.
New property types are becoming staples on lenders' balance sheets. Self storage and mobile home parks now make up to 40% of many lenders' programs and are now highly regarded for their steady income potential. Hotels, auto parks, assisted-living/congregate care, student housing, golf courses, for- sale condo and town houses, and movie theaters are becoming standard products, as spreads over 200 can still be generated.
When it comes to process, lenders must look to drive volumes by becoming more efficient and cost-effective and at the same time respond to borrower requests for early rate locks and commitments. Lenders are targeting 30-day closes (15-day commitments and 15 days to close). Internal and third-party efficiencies must be developed.
One method of achieving efficiency is by segmenting small- and large- loan programs. Small-loan programs would utilize abbreviated/standardized underwriting and due diligence, allow no negotiation of loan documents (or permit them at additional cost), streamline (or combine) appraisals, engineering and environmental reports, and eliminate the commitment stage.
Large-loan programs would utilize detailed due diligence and underwriting, tighter controls and approval process, and extensive evaluation of borrower credit, cash flows, and market constraints.
Timing and fees are also contingent on third-party inputs. All-in fees are being targeted at 1.5% to 2% of the loan amount, down from an average of 2.5% currently. Lenders have been working with the third parties and the rating agencies to determine ways scope and presentation can be decreased to make this fee structure work.
Information systems are the third solution lenders are looking at to create efficiencies both internally and externally. End-to-end solutions, capable of rolling together information from origination through servicing and reporting, are being developed by the large banks that eliminate redundant inputs, automate the pipelines, reduce errors, and provide portfolio modeling and analytical capabilities.
Lenders are integrating third parties into the system by allowing network access and information transfer to speed document transfer, standardize the delivery process, and move toward a paperless format. The next wave is providing access to borrowers (rates and underwriting information) over the Internet for "virtual loan shopping."
It is possible for lenders to make money in a borrower's market, but not without establishing the appropriate relationships, products, and processes. Firms will continue to jockey for position, and consolidation will continue to reshape the industry, so lenders must choose carefully who to partner with.
Product and property expansion will continue as lenders look for untapped markets, but risk-based pricing must be evaluated closely to ensure the long-term viability of these transactions. Internal and external processes must be standardized and improved to create maximum quality with minimal throughput time to achieve critical deal volume.
