Securing the financing of an office contract becomes easier

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Prior to the pandemic, investors were passionate about office buildings in the United States, with apparently no problem securing financing for Class A and Class B buildings well located in major and growing secondary markets. In 2019, about 20% of the total loan production of commercial real estate lender Walker & Dunlop was in the office sector, according to Jeff Morris, general manager of the Columbus, Ohio-based capital markets group with the company. “The market was fluid and CMBS insurance companies and lenders were open to high quality office loans,” he says.

Not surprisingly, COVID-19 has changed the way lenders view office assets, at least for the immediate future, Morris notes. Last year, some existing loan portfolios suffered from tenant default and many loans had to be reworked, with forbearance agreements put in place to avoid defaults. “Lenders didn’t think employees would go back to the office,” Morris said, adding that Walker and Dunlop took out a $ 9.1 million office loan in 2020, with little leverage for a very special building. and high quality in Columbus.

In the second quarter of 2021, the Mortgage Bankers Association’s original volume index for office buildings saw a 149 year-over-year increase, reaching a score of 137 (where the average quarter of 2001 = 100). It was the first jump in loan origination after three-quarters of double-digit declines. From the start of the year through the second quarter, office loan origination increased 22%. Sales of office investments in the first half of 2021 were up 6% from the previous year to $ 47.5 billion, according to real estate data firm Real Capital Analytics (RCA). This is the smallest increase for all RCA real estate channels except development sites.

With rent growth projections still falling and concessions rising, underwriting standards for office acquisitions have become more stringent over the past year and a half as lenders seek coverage in place and demand ratios of hedging and higher debt yields. “They’re looking at loans per square foot, equity, and locations with a critical focus,” Morris explains, noting that while 2019 loan-to-value (LTV) ratios could reach 75 percent, they’re now over 65 to 70. percent.

Last year LTV didn’t even make a difference in getting loans unless it was too low, say 25% for a higher asset, and those situations didn’t exist, he said. . Today, lenders may be interested in office assets well located in suburban areas at 50% LTV, or office buildings in central urban markets at 60% LTV. But there just isn’t enough data in the market to say it for sure, as there aren’t many office investors looking for funding, Morris notes. According to real estate services company CBRE, average LTVs for all commercial loans in the second quarter of the year were on average 58.6%, compared to a pandemic low of 53.9% in the third quarter of 2020.

The lender’s DSCR requirements for office loans are specific to the case, according to Andrew Asbill, managing director, capital finance, structured finance, at real estate services company Transwestern. Morris says that DSCRs go hand in hand with LTVs, so generally DSCR levels are very wide, because interest rates and leverage are low.

“In 2021, we still haven’t seen office opportunities return to where they were before – rents have gone down and values ​​have fallen, and lenders just don’t believe the ‘back to the office’ story just yet. “, Morris notes. He says the only significant office transactions completed are for mixed-use properties with multi-family or owner-occupied buildings, noting that Walker & Dunlop has only closed two office loans so far this year, one in one. office building in downtown. Minneapolis for $ 16 million and another for just over $ 2 million. Together, these transactions represent just 1.4% of the company’s expected origination volume this year.

Walker & Dunlop was able to finance the building in Minneapolis for several reasons, including its location in the Central Business District (CBD); the fact that it belongs to one of the best sponsors in the local market; his profile as a top tenant; and, more importantly, that the loan was a substantial discount from the original cost of this new building, so there was a lot of real equity. According to Morris, lenders currently willing to work in the office market include ultra-conservative insurance companies (which focus on very low LTV transactions or top-notch property owners with high rents), as well as bridge lenders and debt funds.

Asbill agrees, saying most of the office lending activity his group sees is through debt funds. He notes that some banks and life insurance companies “dip their toes in the water” but are very selective and typically only lend on Class A or trophy properties with very strong sponsors.

Over the past two years, banks and life insurance companies have entered into numerous industrial and multi-family transactions, so much so that they are now under-allocated to offices and looking to balance their loan portfolios, notes Asbill. . As a result, “we have seen some banks and life insurance companies become very aggressive in pricing quality assets with strong sponsorship. “

According to RCA data, the makeup of office lenders in 20201 looks like it was before the pandemic. CMBS lender business accounted for 31% of office loan origination in the first half of this year, making it the industry’s leading source of funding. Investor-focused lenders, such as debt funds, accounted for 17 percent of office loan origination, while smaller and regional banks financed 21 percent of office acquisitions. Among CMBS lenders, the average office loan was around $ 58 million, up from $ 28 million last year, while the average loan size among small banks was $ 5.8 million.

Lenders remain very selective about the location of assets, the market and the borrower. Blue-chip office buildings in unprecedented locations are the most likely to get acquisition financing, according to Morris. “Nationally, the top eight to ten markets, known as ’24 hour cities’, are seeing slight action, but it is selective. Office buildings in the urban cores of trendy small towns, including Columbus, Indianapolis and Nashville, Tennessee, are also attracting interest from lenders.

According to Asbill, loan originators mainly focus on existing clients who are well-capitalized and have a strong track record, but there is debt capital available for new investors. “It usually comes from debt funds with higher coupons or possibly from a bank, if the borrower is willing to sign up for a principal recourse. “

Morris adds that lower-balance loans, like his company’s $ 2 million deal with an insurance lender, can be attractive to some lenders, especially for owner-occupied buildings. Asbill notes that regional and community banks, as well as credit unions, are active in this small lending space.

Summarizing today’s office lending environment, Morris says, “It will take a little longer to recover. Many lenders who have large concentrations of office buildings have had to rework these loans, so there is a tempered motivation. “

But building on his 40 years of lending industry experience, Morris predicts that as tenants return to offices, the industry will come back in favor among lenders, and they will once again compete for loans. .


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