Seller Financing Surges as Way to Break the Gridlock

Experts are debating how to interpret a new survey showing that sellers have dislodged banks as the principal source of financing for commercial real estate.

It is clear, though, that some sort of groundswell is evident in survey results announced last week by the National Association of Realtors.

Seller financing is a way of "breaking the transaction gridlock," said Richard Kately, executive vice president of the Real Estate Research Corp.

"It's not going to clear the real estate markets, but it is a step in the right direction," Mr. Kately said.

Wide Range of Interpretations

Beyond this assessment, however, the implications are not so certain. Some experts said that the change signals that the bottom of the real estate downturn is near. Others see seller financing as merely the latest measure of desperation in a marketplace with no bottom in sight.

Bank loans accounted for only 29% of the 450 recent transactions reported in a summer survey, down from 44% of transactions reported in the spring, according to the realtors' association survey.

While noting that "sellers" made 34% of new real estate loans that respondents described as their most recent deals, the association said the sellers include some banks.

The sharp uptick in seller financing can be read as a further sign that banks are racheting down real estate prices in hopes of reviving the market.

Little Agreement on Price

Real estate values have been locked in a downward spiral with buyers and sellers unable to agree on price, Mr. Kately said. By financing the sale of their own property, he said, banks and other lenders are able to reduce the price to a level acceptable to buyers, while taking a smaller hit than they would if they were to sell for cash or hold the property.

Mr. Kately said that sellers also include the Resolution Trust Corp., which is putting the property of failed savings and loans back into the marketplace, and, very recently, life insurance companies who are in a similar predicament to banks as real estate collateral erodes.

David Shulman, managing director of Salomon Brothers Inc., took a more jaded view of a shift toward seller financing.

Mr. Shulman said seller financing always rises after the bottom drops out of the real estate market. It merely indicates that prices are still too high for the buyers to find loans from third parties.

The real estate markets will be scraping along the bottom two years from now, he predicted.

Hoping for Better Days

The way Mr. Shulman describes it, the banks are accepting a small amount of cash and a piece of paper for their real estate, hoping that things will get better before the loans come due again. "You couldn't sell that piece of paper at the stated price," he said.

Nevertheless, it is the first time since the quarterly survey was initiated in 1985 that banks fell to second place behind "sellers" among sources of loans for real estate investment.

Many a respondent who checked the "seller" item on the questionnaire sent along a note saying the transactions in question involved foreclosed property, said Lorena Ruth Ludeman, financial economist for the National Association of Realtors.

The association also noted an uptick in cash transactions -- which it attributed to bargain hunting by wealthy investors -- as well as continued tightening of underwriting standards.

Finance Sources Shriveling

The rise in cash transactions, to 23% from 16% in the spring survey, also signaled the difficulty many borrowers had in finding financing of any kind, the realtors' association said. Indeed, transactions were so few, the NAR said, that its results were statistically insignificant except at the national level.

The survey has been turning up data on 400 to 450 transactions a quarter since spring 1990, when the association's nearly 15,000 members reported more than 800 transactions.

This summer, "at least 11% of the surveys returned reported no activity," the trade group noted.

The ratio of expected cash flows to debt service -- the debt coverage ratio -- rose to a mean of 1.22, from 1.19, indicating continued conservatism on the part of lenders.

Similarly, the mean loan-to-value ratio reported fell slightly to 73.5% from 76%.

S&Ls Role in Apartments

Interest rates fell to a mean of 9.77% from 10.33% during the quarter, while the mean maturity of the real estate loans fell to 20 years.

Although banks' role was reduced, they remained the predominant financer of office investments, providing the loan in 48% of office sales. Savings and loans, meanwhile, continued to play a significant role as lenders in apartments, making 23% of the loans on such properties. "Sellers" financed 28% of the apartment deals.

Life insurance companies were fleeing the market, but respondents said some midsize companies remain willing to make real estate loans.

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