Research: Commercial Lending Improves

The Expectations & Market Realities in Real Estate 2015: Scaling New Heights report—released by Situs, RERC, Deloitte and the National Association of REALTORS® (NAR)—points to a commercial real estate market which has benefited from improved macroeconomic conditions and bullish capital markets. During 2014, gross domestic product rose, employment growth accelerated, and stock market indices reached new heights. Consumer confidence improved and oil prices declined sharply, adding wind to the sails of economic activity.

Commercial vacancy rates declined for the core property types. Availability is expected to continue contracting for office, industrial and retail properties in 2015 and beyond. Vacancies for apartments are estimated to rise, due to gains in supply. Commercial rents have risen across the board, and are projected to advance this year to the tune of 2.5 percent to 3.7 percent.

Sales volume continued its positive trend in 2014, with $438 billion in closed transactions, compared with $361 billion in 2013, based on data from Real Capital Analytics (RCA). Most of the transactions reported by RCA are based on data aggregated at the top end of the market—above $2.5 million.

In contrast to the large commercial transactions reported by RCA, commercial members of NAR managed transactions averaging $1.6 million per deal, frequently located in secondary and tertiary markets, and focused on small businesses and entrepreneurs. The Commercial Lending Trends 2015 report recently published by NAR shines the spotlight on this significant segment of the economy—a segment which tends to be somewhat obscured by reports on large Class A commercial properties.

Based on NAR’s 2015 survey of members, lending conditions in markets notched a year of sustainable recovery. Commercial asset prices strengthened, and cash flows continued rising, with 48 percent of respondents indicating higher net operating incomes over the past five years. Riding upward trends in fundamentals, financing and lending conditions improved in 2014.

Local and community banks were the largest lending group in commercial markets accounting for 32 percent of transactions. Local and community banks gained market share from 2013, when they made up 30 percent of the market. The second largest capital source in 2014 comprised of regional banks, which captured 26 percent of REALTORS®’ commercial deals, a slight increase from the 23 percent in 2013.

Private investors were the third main capital providers, accounting for 11 percent of deals during 2014. National banks came in fourth place, with 7 percent market share. The Small Business Administration and credit unions made up 6 percent and 5 percent, respectively, of transactions. Life insurance companies were much less active, representing 3 percent of deals, while CMBS conduits accounted for only 1 percent of funding, tied with REITs and public companies.

The incidence of failed transactions—due to lack of financing—reached a new low. However, it is worth noting that over four-in-ten REALTORS® reported financing issues having caused transaction failures. The main reason for financing leading to incomplete transactions—cited by 62 percent of commercial practitioners—was banks’ loan underwriting standards. Appraisals accounted for another 19 percent of failed transactions.

Even with the recovery on a more solid footing, 58 percent of REALTORS® continued to find bank capital allocated to commercial real estate insufficient. About one-in-four members cited uncertainty from legislative and regulatory initiatives as the most relevant cause for the shortage. Financial regulatory uncertainty and weak fundamentals (NOI, values, equity) accounted for 20 percent each of bank capital shortage.

As commercial markets continue to be dependent on community and regional banks, and—as opposed to top-tier markets which benefit from equity contributions—for these markets debt financing represents a much-larger portion of capital, the raft of financial regulations which has hit the industry over the past six years has left a deeper impression on available capital for commercial deals. With higher costs of compliance and higher capital reserve requirements for commercial loans, regional and community banks will likely continue to be more cautious in their lending.

Download the entire Commercial Lending Trends 2015 Report.