Lenders remain hungry for new real-estate deals

Thanks to March jobs data indicating an almost unbelievable turnaround in job creation, commercial mortgage rates are roaring higher.

On top of the jobs report, which was released earlier this month, several consumer price and retail sales indicators have shown signs of inflation.

With that, U.S. Treasuries are out of favor, and prices are falling. Because Treasury yields move in the opposite direction of price, yields are up and bringing commercial mortgage rates with them.

Rates for 5- and 10-year loans are now 4.80 percent and 5.80 percent, respectively, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

Despite the uptick in Treasury yields, lenders remain hungry for new business and are offering extremely aggressive spreads (spreads are added to Treasury yields to arrive at the commercial mortgage rate).

As is typical, apartment loans are getting priced most favorably. High-quality, fully leveraged apartment loans are attaining sub-100 basis point spreads on a regular basis. Lower-leveraged apartment loans can get priced closer to 70 basis points over Treasuries. This corresponds to interest rates of 5.05 to 5.1 percent. (A hundred basis points equal one percentage point.)

The battle for new loans has also led, predictably, to a relaxation of underwriting standards. Where lenders previously sized loans using a debt-service coverage test that rarely went below 1.00X using a standardized rate and amortization known as the "Fitch constant," they now are easing the coverage test to .90X.

Simply put, a property's cash flow that previously warranted a $10 million loan now can achieve an $11.1 million loan. More aggressive underwriting has not gone unnoticed by the industry's watchdog - the rating agencies. Says Tad Philipp, head of the commercial mortgage-backed securities group at Moody's rating agency: "We're beginning to see some chinks in the underwriting armor."

Although loan supply is quite good, there clearly is more demand for loans by lenders than there is supply. This has led many investors to look at alternative property types and financing vehicles to invest money and gain extra yield.

Here in Richmond, a possible recipient for these yield-seeking dollars could be the Richmond Ballpark Initiative.

While debate regarding the proposal to build a minor-league ballpark in Shockoe Bottom has centered on parking and preserving older buildings, there is little doubt that financing will emerge as a central point of contention.

From the city's perspective, deciding between a new ballpark closer to the Broad Street/Convention Center and Shockoe Bottom area or keeping The Diamond is like deciding between putting Derek Jeter or Miguel Tejada at shortstop. There is nothing wrong with Tejada, but if you could afford Jeter, that would be your choice.

A financing structure to watch for as this debate brews is CDA (Community Development Authority) bonds like those used for the improvements along Broad Street near the convention center. There are two scenarios under the bond structure that could come into play, and many derivations thereafter.

The first calls for repayment of investor proceeds through a special district tax that is approved by at least 51 percent of the participating landholders in the district. The second is structured as a revenue bond, and the CDA bonds would be repaid from revenues generated by what is built with the funds (parking structures, stadium revenues, etc.).

According to Gary Fenchuk, the president of East West Partners of Virginia who has been involved in more than $100 million of CDA bonds, the special district tax needs to have more than the 51 percent support required by law to be successful.

Other derivations in addition to the CDA bonds could be in the form of tax increment financing provided by the city and the funds currently allocated to renovate The Diamond.

Andrew Little is an investment banker with John B. Levy & Co. He can be reached at alittle@jblevyco.com