The Urge to Merge

The recent flurry of acquisitions in the commercial real estate finance sector is an outgrowth of the industry's maturation, as commercial real estate takes its place among other mainstream investment products.

This maturation has accelerated over the past 15 years, coinciding with commercial real estate's rebound from a deep slump in the early 1990s to experience dramatic increases in property appreciation. A very favorable interest rate environment and access to global capital markets has led to a much greater presence of public investors in this sector.

Dominant players emerge

In 1990, commercial and multifamily real estate debt totaled approximately $1 trillion. This total surpassed $2.7 trillion in the first quarter of this year, demonstrating the significant growth in the commercial real estate finance industry.

This surge in investment has been accompanied by consolidation, as companies position themselves to capitalize on competitive advantages and align themselves selectively with business partners that complement their business profile and provide growth opportunities.

This consolidation trend is evident if we look at the concentration of servicing in the largest firms as a proxy for consolidation. In September 1996, the Mortgage Bankers Association (MBA) Annual Survey of Commercial Mortgage Servicers revealed that the top 10 servicers at that time serviced approximately 50% of the reported servicing volume. The remaining 50% was distributed among 127 firms (see chart). At year-end 2005, the top 10 companies serviced approximately 78% of the volume reported by survey respondents, with the remainder serviced by 77 companies.

Agents of change

New, sophisticated entrants have greatly influenced the market, giving rise to more complex debt structures. Capital users now include private owners of real estate, as well as institutional owners such as pension funds, opportunity funds, real estate funds, insurance company portfolios, REITs and foreign investors.

Moreover, all market players — capital users, sources, and intermediaries — are varied and have developed complex and interwoven relationships. For example, mortgage bankers have fashioned more diversified real estate platforms to facilitate one-stop shopping between borrowers and investors, leading to synergies, cost savings and product enhancements. Platforms may offer products and capital for all property types, and may act as both a principal and intermediary.

The recent flurry of acquisition activity follows a similar pattern in other maturing industries. Over time, leading companies boost revenues by increasing market share, expanding product offerings and achieving economies of scale. Additionally, they evaluate cost-cutting opportunities, and embrace technology to streamline operations and lower their costs through outsourcing.

In May, Wachovia Corp. completed its acquisition of American Property Financing (APF). The acquisition will enhance Wachovia's financing and servicing capabilities and provide the banking giant with a stronger presence in the New York City multifamily lending market.

Then in early June, FirstService Corp. acquired a majority interest in Cohen Financial as another important step in the company's strategy to provide a full suite of services to its clients. FirstService intends to leverage Cohen Financial's extensive broker network in order to achieve that goal.

On the same day as the FirstService Corp. acquisition announcement, Wells Fargo & Co. announced that it had signed a definitive agreement to purchase the assets of Reilly Mortgage Group. The deal will strengthen Wells Fargo's presence in the multifamily arena and broaden its array of financial products and services.

A week later, CharterMac announced that it had agreed to acquire 100% of the ownership interests of ARCap Investors LLC. CharterMac deemed the acquisition the next step in the transformation of the company from a spread investor to a real estate fund manager, and a logical expansion of the fund management platform into a new area of real estate finance.

The road ahead

With the commercial real estate finance industry becoming more commoditized, traditional mortgage bankers will continue to find success in this dynamic business environment by providing specialized functions and broadening their capital sources, and as a result respond more nimbly to changing conditions.

Businesses have adapted to market dynamics by aligning with strategic partners that facilitate their growth, enhance their profit-making potential and enable operational efficiencies. Opportunities have emerged for companies of all shapes and sizes, as the entrepreneurial commercial mortgage banking industry adapts ably to market changes.

Gail Davis Cardwell is senior vice president of the commercial/multifamily division at the Mortgage Bankers Association based in Washington, D.C.

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