The lending efforts by regional and community banks in regard to commercial real estate have, since the end of the recession, been strongly directed toward multifamily. At the end of last year, almost 50 percent of loans to the multifamily sector came from regional and local banks, according to industry data, versus 17 percent for the retail side. That is changing. “Multifamily is such a competitive place that lenders had to venture out if they wanted to do loans; that’s one side of it,” said Shahin Yazdi, a principal at Los Angeles–based George Smith Partners. “The other side is [that] the retail market as a whole has seen such great improvement, with rents going up and space being filled.”
The regional and local banks that survived the recession generally had good balance sheets and were able to grow by taking on loan officers from other financial entities, including the big banks that had gotten into difficulties. In addition, the Federal Reserve has kept the discount window so low that there is a great arbitrage opportunity for banks to borrow short-term at a low rate and lend long-term at a higher rate.
“For commercial real estate, the percentage of loans from regional banks has been increasing,” said Jim Costello, a senior vice president at New York City–based Real Capital Analytics. “While all capital sources have increased lending, the regional banks are expanding faster. What it gets down to is, the regional and local banks have a low cost of capital and want to earn a good return on it; commercial real estate is offering good opportunities.”
In 2011 the regional-bank share of the commercial real estate lending market was less than 10 percent. Last year that jumped to 14 percent, according to Real Capital Analytics. As of the start of the fall, retail property lending was still up for the year versus the year before. But following a torrid first quarter, the market slowed substantially during the summer, with overall retail real estate lending dropping by 6 percent in July, year on year, and then collapsing by 17 percent year on year in August, according to Costello.
In addition, turmoil in the global financial markets, including the devaluation of China’s currency, put a crimp in the commercial-mortgage-backed-securities market, traditionally the main lending source for retail real estate. Regional banks are stepping into the gap, especially as the yields on multifamily have diminished. In Irvine, Calif., Opus Bank has been actively expanding its portfolio with retail lending. “Our portfolio was mostly multifamily where we have a competitive product and a robust pipeline, but with cap rates higher on retail than on multifamily, we saw an opportunity to expand the portfolio,” said Ed Padilla, Opus Bank’s head of commercial real estate. “About three to four years ago, we saw multifamily rates were being compressed because of competition, and there was an opportunity to diversify the portfolio while picking the right retail deals and achieving a slightly higher yield.”
The bank’s deal pipeline now stands at $1.2 billion, with 40 percent in commercial real estate and 60 percent still in multifamily. The bank lends on the West Coast, chiefly in its core markets of Southern California, Northern California, Phoenix, Seattle, and Portland, Ore. In retail the -company prefers smaller properties such as neighborhood and strip shopping centers. “We had a borrower come to us for a $2.5 million acquisition loan on a strip center in Glendale, California,” Padilla said. “The opportunity was a reverse 1031 exchange, and Opus was able to understand the deal quickly and close in about 35 days.” Opus Bank closes approximately 50 loans per month, Padilla says.
Regional bank deals are often a lot cheaper than even CMBS, because the banks have streamlined loan -documentation, reduced closing costs and lowered processing fees, says Yazdi. “Some don’t require phase one [environmental] and don’t have expensive legal fees,” Yazdi said. “A borrower could see $5,000 to $10,000 in savings on a straight retail deal.”
According to a Real Capital -Analytics lender composition survey, “regional/local banks have average loan sizes far smaller than other lenders.” Last year insurer loan sizes averaged $27.1 million, CMBS averaged $14.3 million, and at the bottom of the list were regional or local banks with an average loan size of $5.4 million.
Portland-based Umpqua Holdings Corp. (doing business as Umpqua Banks), which has a five-state footprint in the Northwest, takes a different approach, lending on retail into the low-$20-million range. It will do construction loans, value-add redevelopment and mixed-use. “We look at several types of retail real estate, but what we really focus on is the experienced developers who we have relationships with that are our clients,” says John Swanson, Umpqua Bank’s executive vice president of commercial banking. “Retail is so specialized that we try to align ourselves with who we think are the key developers for the types of products that fit our market.” Less than 20 percent of Umpqua Bank’s construction and permanent loan volume is retail, with a -major swath still going to multifamily.
It is not just size that makes a -difference with regional lenders — placement is key as well. “In terms of retail, we are seeing increasing interest mostly because the fundamentals have recovered nicely and vacancy rates finally dropped into the two-digit territory,” said George Raitu, director of quantitative and commercial research for the National Association of Realtors, Washington, D.C. While that may be true in general, the success of regional lenders depends on the individual markets. “In gateway metros such as New York, retail is seen as a trophy property, and the lending sources range from sovereign wealth funds to big life insurance companies,” said Raitu. “On a list of lenders for big cities, regional lenders are way down, the sixth- or seventh-busiest sources.”
That all changes with second- and third-tier cities. “In smaller metros, the number-one lenders are the smaller banks,” said Raitu. “Banks are the main funding source for commercial real estate transactions, including retail. All other sources fall in place behind.”
Regional or local banks prefer recourse loans, which means that if the bank forecloses, it will go after the sponsor, the individual who signs the personal guarantee. “Our deals are recourse,” said Swanson. “We closed one this year that was nonrecourse or limited recourse, but it was a very conservative loan. You start getting into 50 percent loan-to-value before we start talking about nonrecourse.” Far and away, most commercial real estate loans from Umpqua Bank are recourse, especially when it comes to construction. “If someone is looking for a full loan amount and doesn’t want recourse, it is not a deal for us,” said Swanson. “But if there is a way to structure a deal to make it work, such as limited or reducing recourse, we will do it.”
It may pay to be flexible. As the regional banks’ appetite for retail is growing, more of the lenders are considering nonrecourse, says Yazdi. “If you have a strong deal that the bank believes in, within a good market, the banks will give you that nonrecourse loan so they can stay competitive with CMBS.”
Recourse or nonrecourse also depends on what a bank does with its loans. “Some banks keep debt on the balance sheet and would be more interested in keeping a loan as recourse,” said Raitu. Not that banks are taking unnecessary risks. The default rate for commercial mortgages over the past few years has stayed below 3 percent, says Raitu. And this at a time when loans for commercial real estate have been increasing.
“It’s not as though anyone is retreating,” said Costello. “The whole pie is getting bigger, but some types of lenders have gained market share. All types of lenders have been increasing deal flows — it’s just that the regional banks are growing faster.”
