Perspectives

The CRE financing squeeze

Can companies find funding alternatives?

Commercial real estate (CRE) companies are facing a double whammy: cooling property prices and a financing squeeze. Heated valuations and recent decline in property prices have increased banks’ concerns about their CRE loan exposure. As a result, they are tightening loan standards.

July 26, 2017

A blog post by Surabhi Kejriwal, Real Estate research leader, Deloitte Services LP

Property prices have started to contract due to the slow transaction market as investors express skepticism about the strength of the pricing environment. This is evident in the consistent marginal decline in the index value over the last four months ended June 1st. In fact, the index value remained flat for the prior four months ended February 1st.

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Tightening lending standards

In response, banks have started tightening lending standards. According to the Federal Reserve’s April Senior Loan Officer Opinion Survey on Bank Lending Practices:

  • Banks have significantly tightened credit standards for multifamily and construction loans compared to CRE loans. Specifically for CRE loans:
    • 32 percent of banks have tightened the interest rate spread
    • 3.9 percent have increased the debt service coverage ratio
    • 11.1 percent have lowered the loan-to-value ratio
  • A substantial proportion of large bank respondents cited concerns about property prices and vacancy rates outlook for tightening loan standards. Relatively, a large proportion of smaller banks have expressed concerns about their capital adequacy/liquidity position and inability to securitize CRE loans.

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CRE companies remain heavily reliant on bank lending

But, CRE companies remain heavily reliant on bank lending, especially due to relatively lower commercial mortgage-backed securities (CMBS) issuances.

Among traditional lending sources, the CMBS mortgage origination index showed a decline. In 1Q17, the CMBS origination index decreased 17.4 percent year-over-year. CMBS declines are largely due to the implementation of the risk retention rules and slower property sales.

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CMBS refinancing is challenging and delinquencies are on the rise

CMBS, due for maturity between July and November, are facing refinancing challenges. CMBS delinquency rates have risen steadily over the last year, as the 2006 and 2007 loans that are due to mature face refinancing challenges.

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As such, CRE companies should evaluate alternate sources of financing:

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Are these alternate sources sufficient to fill the impending funding gap? What are your views on the CRE financing crunch? Have you been successful in finding alternative sources of funds?

QuickLook is a weekly blog from the Deloitte Center for Financial Services about technology, innovation, growth, regulation, and other challenges facing the industry. The views expressed in this blog are those of the blogger and not official statements by Deloitte or any of its affiliates or member firms.

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