Money continues to pour into real estate properties

Although reading the latest economic data has become a bit like examining tea leaves, money continues to flow into almost all things related to real estate.

As a result, spreads on commercial loans made by insurance companies are compressing, and commercial real-estate prices are soaring. (The spread is the difference between the interest rate charged on a loan and the yield on a corresponding Treasury security.)

Nevertheless, investors seem unable to get a handle on where we are in the recovery, despite a successful end to the war in Iraq. For example, contrary to popular opinion, the post-war yield on the 10-year U.S. Treasury has remained remarkably stable.

The combination of compressing spreads and a stable to declining U.S. Treasury yield has allowed rates for commercial mortgages to remain low. The Barron's/John B. Levy & Co. National Mortgage Survey finds that rates are down from last month, ranging from 4.5 percent to 5.75 percent for 5- and 10-year mortgages.

The low rates have helped to support an already frothy investment-sales market for most property types, particularly apartments. Even for lower-quality B-and C-grade apartment complexes, investors can expect to pay a price that allows an unleveraged yield of little more than 8 percent.

This high-price environment has created somewhat of a dilemma for many lenders who are having difficulty making loans equal to 80 percent of purchase price. Their nightmare lies in the prospect of providing an 80-percent loan at a 5.35 percent rate that could very well be a 100 percent loan in the future if rates go up 200 basis points (2 percent) and rents remain flat.

As one lender put it, "During uncertain economic times, you better be working harder than everyone else or you're going to book some bad loans."

The underwriting difficulties have not prevented loan volume from continuing on its blazing course. Lehman Brothers is in the market with a large, floating-rate securitization of commercial real-estate loans. The distinguishing characteristic of the offering is that it includes the $300 million hotel loan secured by the Swan and Dolphin hotels at Walt Disney World in Orlando, Fla.

Although few investors are questioning the quality of the Swan and Dolphin loan, the overall Orlando hotel market has been dramatically affected by the severe drop-off in travel.

According to Trepp, LLC, a New York-based firm specializing in commercial mortgage-backed securities analytics and pricing, a staggering 25 percent of the $1 billion in hotel loans in the Orlando area are now either delinquent or in the process of being foreclosed upon.

Furthermore, if you exclude the Swan and Dolphin loan from the mix, the delinquency number would increase to 35 percent.

Here in Richmond, Trepp, LLC indicates that about 20 hotel loans representing almost $100 million have been securitized as commercial mortgage-backed securities. Only two loans have shown up as 30 or more days delinquent.

The first was a $4.6 million Howard Johnson hotel loan in Chester that was foreclosed upon and liquidated in January with a $3.4 million loss.

The other hotel loan is a $4.9 million loan secured by a property in Hopewell that just became delinquent. The newly delinquent loan, in combination with a $23 million loan that was recently paid off, creates a current delinquency rate of 7.24 percent for the remaining loan balances outstanding.

By comparison, the national average is only slightly better at 6.62 percent for hotel loans.

Andrew Little is an investment banker at John B. Levy & Co.