Wednesday, October 12, 2016

Commercial Real Estate Plays It Safe

Rani Molla a Bloomberg Gadfly columnist 

U.S. commercial real estate prices have reached new highs, but the sector is a much safer place today than it was before the 2008 financial crisis.
Moving On Up
Commercial property prices have surpassed pre-recession levels, but that doesn't mean a crash is inevitable

Low capitalization rates -- the net operating income a property generates relative to its price -- might normally keep investors away, but low borrowing costs have made potential returns from commercial real estate attractive.Lenders, for their part, are avoiding many of the risky practices that contributed to the last real estate crash. Thanks to pressure from the Federal Reserve and government regulators, banks have been tightening their commercial real estate lending standards.

Raising Expectations
Share of senior loan officers who reported tightening standards on loans at their banks. Banks have picked up the lending slack caused by a less robust market for commercial mortgage-backed securities. But bank lending largely involves mortgages for existing properties rather than riskier loans for new construction. Banks’ conservatism has made it more difficult for developers to fund new construction, which in turn has prevented many markets from being overbuilt. 

Under Construction
Bank construction and development loans are still 53 percent lower than their 2008 high. Mortgages themselves are more conservative as well, with banks lending against a smaller portion of a property’s value. 

Less Risky Business
Commercial loans as a share of property value are smaller than they were before the recession. Lenders are also requiring borrowers to keep more cash on hand to pay off debts, improving banks' odds of getting repaid.

Owning Up
Lenders are requiring higher debt service coverage ratios -- net operating income to debt services -- than before the crash, meaning borrowers will be more likely to be able to pay what they owe

None of this means there won’t be pain if real estate prices suddenly crash. No amount of structural padding can insulate lenders from a nasty downturn.There are also lots of players in the market who have looser lending standards and may face even more pain than banks should a downturn come. As my Bloomberg colleagues Sarah Mulholland and Heather Perlberg have pointed out, shadow lenders, including private equity firms like Blackstone and Starwood, as well as online crowd-funding sites, are all taking on loans that banks have decided to forego.

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