Banks tighten commercial RE loans: Developers weigh financing options

The lending market for commercial real estate projects is getting tighter, with many banks bumping up against their loan limits.

The Federal Deposit Insurance Corp. sets specific guidelines about how much a bank can lend out for different classes of projects. The size of the bank determines the lending limits the government imposes on them and each bank then chooses its own lending limit below that figure.

“Sometimes, they match it and sometimes they go well below that,” said W. Scott Reichenberg, president/principal of The Colorado Group Inc. in Boulder.

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If they get a request for a loan that is above their lending limit, most banks will participate out part of the loan to a sister bank.

They are the underwriting bank, but they farm out part of the loan to another bank behind the scenes. The borrower has to deal with only one point of contact, and the original bank that underwrites the loan.

“That’s how most banks manage that issue. Most local banks have lending limits that are hard to bump up against,” Reichenberg said.

First National Bank in Fort Collins isn’t bumping up against a general limit with its real estate lending, but it is bumping up against some concentration issues in certain product types such as multifamily housing and hospitality/hotels, said Michael Kuester, senior vice president for First National Bank in Omaha, Neb.

“Those are the two product types for us that we kind of monitor those concentration levels more frequently than we have in the past because we are getting up close to the limits we set,” Kuester said.

Mark Driscoll, Colorado market president for First National Bank, said that “those limits are based on a percentage of the bank’s capital. That’s how we look at it. Capital in a bank is available for two reasons: It helps us grow in good times and cushions us in bad times. That’s the hurdle.”

Kuester added that First National Bank is being very selective with the projects it chooses to underwrite in those two product types. It has to look at what it thinks is coming down the pike, what projects are nearing completion and what the concentration will be for those two product types every quarter.

“As we prioritize different projects and product types we know will occur, we try to save powder for long-time loyal customers who have been with us for years and may have multifamily projects,” he added.

As for the loan-to-value ratio banks shoot for with different types of commercial real estate deals, Kuester says that his bank looks at each project on a case-by-case basis but it would “be extremely rare” for First National Bank to go north of 75 percent. For long-term clients, the bank may consider going as high as 80 percent and for new clients, that number may be closer to 70 percent.

“It depends on what market you are in,” he said. Industrial is a hot product type currently but in some areas of the country, it is getting a little “frothy.”

“Given the fact we have been in an environment of historically low interest rates, we pay attention to stress testing. If interest rates happen to rise, what does the deal look like? That is something we pay particular attention to regardless of what the product type is,” Kuester said.

Leon McBroom, director of HFF, a commercial real estate capital markets firm that capitalizes projects throughout the Rocky Mountain region, said that “when it comes to construction financing, we are starting to see traditional banks either pulling back or pulling out of asset classes due to exposure or they are over-allocated in construction dollars within their portfolio. As a result, they’ve either pulled completely out of the construction markets or are waiting for their portfolio to mature or pay off.”

McBroom helps developers find the financing they need for commercial real estate projects. Depending on the borrower’s relationship, he said, most traditional banks are maxing out at a 65 percent to 70 percent loan-to-cost ratio. However, in some cases, it is much lower than that.

Speculative development and hospitality are two such cases where a construction loan will be less than 55 percent LTC, he said.

“Hospitality is a specialty asset class. Yes, it is a commercial real estate class, but it has a huge operating component that lenders have to underwrite so there is a bit of a premium involved,” he says.

If a developer has a strong project, strong sponsor and a strong lender relationship, the loan-to-cost ratio could exceed the 70 percent threshold previously mentioned. It is new borrowers who will be capped at the lower loan amounts.

A few years ago, borrowers were financing development projects with bank loans up to 75 percent, with the remainder of the capital stack being backfilled with traditional equity, McBroom said.

“Nowadays, what we’re seeing is alternative ways to structure construction loans,” he said. Most projects will start with a loan from a traditional bank, up to 60 percent of the project, and then backfill with mezzanine financing to push debt proceeds up to 75 percent loan-to-cost. Today’s mezzanine financing can cost anywhere from 8 percent to 15 percent, depending on the borrower and the project. However, the blended cost of capital is still efficient.

Mezz financing uses many types of financing vehicles, including debt or equity that is issued by those in the private-sector. It closes the divide between the traditional bank loan and sponsor equity.

Another financing vehicle for commercial real estate is a Participating Mortgage, where a lender provides up to 90 percent of the project cost in exchange for participation in the project profits, McBroom said.

Another option is a construction-to-permanent loan, which allows the borrower to lock in their interest rate and close on the loan before construction begins on the project. These are mostly offered by insurance companies and are reserved for well-capitalized sponsors and strong projects. The construction-to-permanent loans are typically capped at 65 percent loan-to-cost, McBroom said.

Brandon Rogers, a principal at Terrix Financial in Denver, said that his brokerage works with all types of lenders, including banks, credit unions, life insurance companies, Fannie Mae and Freddie Mac and commercial mortgage-backed security lenders for property owners with existing properties.

“Banks today are getting more conservative,” he said. “They are more full; they are running up against capital ratio issues.”

Some banks in the metro area are no longer lending or have disposed of their commercial real estate departments, Rogers added.

Life-insurance companies do a lot of commercial real estate lending but are more conservative than banks, offering lower rates for longer periods of time. They will do non-recourse loans depending on their leverage on the loan.

Commercial mortgage-backed securities offer up to 70 percent loan-to-value with a 30-year amortization, typically non-recourse at a 10-year fixed rate, he said, but these are “costlier loans and there is less certainty on the interest rate until you get to closing, but it’s a viable product.”

Credit unions have different guidelines than banks when it comes to commercial real estate lending.

“We are finding credit unions much more aggressive than banks right now,” Rogers said. “The lenders of last resort are private lenders.”

Private lenders are used to bridge the gap on a project for a few months and are usually at a higher rate. Many marijuana businesses must go through private lenders because traditional lenders won’t work with them.

Rogers says his company has seen a huge demand for fixing up neighborhood retail strip centers in the past three years because, unlike big-box retailers, Internet retailers can’t put a strip center out of business. These are the places where you find liquor stores, restaurants and nail salons.