Somewhat surprisingly, commercial mortgage lending is staying active

Seemingly at odds with the slowing economy, commercial mortgages continue to show surprising strength, both in high volume and low delinquencies.

During August, commercial mortgage rates fell to new lows for the year according to the Barron's/John B. Levy & Co. National Mortgage Survey and now are in the 6.75 percent to 7 percent range. Indeed, the economic slowdown, which led the Federal Reserve to make its seventh rate cut of the year last month, is the reason for the almost 0.50 percentage-point drop in the 10-year U.S. Treasury yield during the past two months and the corresponding reduction in commercial mortgage rates.

The market for commercial mortgage-backed securities - known as CMBS - and for whole loans are experiencing unprecedented volume in combination with very low delinquencies.

Despite the increased loan production, mortgage spreads (the premium charged over Treasuries for commercial mortgages) are declining. Perhaps history will point to these forces as "The Perfect Storm," but the combination of tightening spreads and a lower Treasury yield has created a perfect rate environment for borrowers.

While interest rates are certainly looking rosy, the underwriting environment is distinctly thorny as lenders indicate their concern for the economy's effect on real estate by offering borrowers less proceeds. More conservative loans are a product of stricter lending guidelines, particularly for suspect property types.

Hotels and motels are the easy answer to the question "What are suspect property types?" This asset class is perhaps the quickest barometer of a slowing economy because the rent roll changes every night. Hoteliers will readily admit that times are getting tougher, as companies and consumers cut back on travel budgets and discretionary spending.

Another asset class that is actually more notorious in a slowing economy is senior housing and assisted living facilities.

According to CMBS research recently published by Morgan Stanley, senior housing shows the highest delinquency rate of any commercial mortgage bundled up and sold as commercial mortgage-backed securities.

The research indicates that 6.35 percent of all senior housing CMBS loan balances are delinquent or were foreclosed upon, nearly four times the rate of the next closest property type, hotels at 1.59 percent.

On average, delinquencies are low, but the speed and depth of the economy's turn has likely not been fully realized by lenders. An example locally is the proposed sale of Gaskins Retirement Center, a newly constructed 48-room assisted living facility in Richmond's West End.

Although the facility obtained a certificate of occupancy in December, it is now entirely vacant and up for sale. To be sure, when construction began on the building, the economy looked much stronger than it does today.

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Andrew Little is an investment banker with Richmond based John B. Levy & Co.