Liquidity Crisis Averted

With a weak economy and the prospect of war, real estate investors are understandably nervous. The good news is that they aren't handcuffed by a 1990s-style liquidity crisis that brought the industry to a standstill a decade ago.

In the past few years, the commercial real estate market has been buoyed by a liquid secondary market for debt created by the soaring volume of loan sales and loan securitizations. Commercial real estate loan securitizations now exceed $60 billion annually while commercial real estate loan sales are estimated to be $10 billion per year and growing rapidly. This new liquidity is fundamentally changing the dynamics of commercial real estate lending and is likely to exert a greater influence on the market in years to come.

For commercial real estate investors, what are the most significant and immediate benefits from this new wellspring of liquidity? First, credit is more readily available today than in previous economic downturns and will remain available, even if market conditions do not improve. Additionally, pricing decisions are becoming more rational because the secondary markets provide lenders with an independent price comparison for similar loans, validated each day by the collective wisdom of buyers and sellers.

Impact of the Internet

Commercial real estate investors have more access to credit in this business cycle than in previous ones because lenders are using the secondary market to dispose of debt efficiently and quickly, thus freeing up capital for additional lending. The Internet has substantially reduced the friction in selling loans by facilitating online loan analysis, due diligence and bidding, as well as the use of online data to set debt prices. As a result, the Internet has reduced the loan sale process from 120 days to 45. Ten years ago, when the Internet didn't exist for commercial purposes, bank debt was largely illiquid.

This newfound liquidity in the secondary market has enabled bankers to alter their lending strategies to accommodate more investment financing. Today, lenders are often making a loan with the intent of letting it season for two years and then selling it individually, in a pool of loans, or packaged as commercial mortgage-backed securities (CMBS).

Equally as important, lenders increasingly are taking advantage of the secondary market to buy commercial real estate loans to balance or fine-tune the composition of their portfolio and to minimize risk.

Diversification Is Driving Liquidity

The key reason liquidity is unlikely to dry up anytime soon is that structural forces in the commercial real estate lending industry are effectively institutionalizing the secondary market. After the hard lessons of the 1990s, regulators are wary about overexposure to any asset type, particularly commercial real estate.

Bank shareholders have concerns of their own. Lenders with a sizeable portfolio of non-performing loans can damage share prices quickly. Therefore, selling problem loans in the secondary market can lead to an immediate boost in share prices.

One of the most important collateral benefits of the thriving secondary market — and a unique difference in this business cycle — is that local real estate markets are enjoying a new level of liquidity. National and regional lenders are regularly selling debt held on properties located in suburban or rural areas to investors from outside the region. The secondary market's ability to factor in risk for regional differences is making those transactions both possible and profitable for market participants.

A New Age of Rational Pricing

In addition to greater availability of credit, the secondary market is rationalizing the loan pricing process for commercial real estate investors. The reason is that the secondary market is providing an objective, immediate and independent benchmark for comparison.

For both bankers and investors, the secondary market provides a daily reference point for prices on all kinds of loans. In fact, both parties can look at the same trade data to make their own case for the most advantageous terms. The tyranny of best guesses, anecdotal evidence, or some other criteria is giving way to hard numbers from actual trading — available for all to see.

The net effect of this greater liquidity is not only more available credit and more systematic pricing, but also a higher comfort level among bankers. These are positive trends for the long-term health of the commercial real estate industry.

Kingsley Greenland is CEO of Boston-based DebtX, a dedicated loan sale advisor for commercial debt. He can be reached at [email protected] or (617) 443-9199.

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