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Bracing For Higher Interest Rates

The feverish pace of commercial real estate financing activity that characterized 2003 has only intensified, say industry experts, spurring lenders and intermediaries alike to heighten projections for 2004 despite an expected increase in short-term interest rates.

Eugene J. Godbold, president of commercial real estate banking at Bank of America, says a limited hike in short-term interest rates does not pose a threat to the healthy lending environment.

“Everybody has contemplated this for the last year or so, and people are prepared for it,” he says. “I do not see a significant impact if rates rise a (percentage) point or so in an organized fashion.”

Bank of America ranks No. 1 in NREI's Top Direct Lender survey, having provided $29.6 billion in financing to the commercial real estate industry during 2003.

Robert Feller, CEO of No. 2 ranked GMAC Commercial Mortgage Corp., says he fully expects the company's volume to swell in the second half of 2004, surpassing last year's direct lending total of $22.5 billion. The lion's share of GMAC's lending this year will be refinancing and acquisition loans, Feller says.

Active Intermediaries

The Mortgage Bankers Association (MBA) reports that the volume of commercial and multifamily loan originations registered $17 billion in the first quarter, 2.8% ahead of last year's pace. Rising interest rates and high vacancies would typically slow originations, but Doug Duncan, the MBA's chief economist, predicts loan originations will remain relatively stable this year due to the current economic expansion.

Ed Padilla, CEO of NorthMarq Capital, believes it is time for the Fed to raise short-term rates. While a rate hike will slow economic growth, that should stabilize medium- and long-term rates, Padilla says. “That may not be a bad thing.” NorthMarq ranks fifth on NREI's list of intermediaries.

Second-ranked intermediary Holliday Fenoglio Fowler has already arranged two $500 million loans in 2004 and is projecting more than $17 billion in volume this year after ending 2003 with $16.2 billion, according to Scott McMullin, executive managing director in Holliday's Los Angeles office.

Volume is also stronger this year at No. 3-ranked L.J. Melody & Co., which recently arranged $490 million in financing for the U.S. Department of Transportation's new headquarters in Washington, D.C.

Brian Stoffers, executive managing director and COO of L.J. Melody, says he is concerned about the rapid rise in the 10-year Treasury yield this year, and he predicts the increase will curb a trend toward record sale prices as buyers face the prospect of lower returns on their equity. The 10-year Treasury yield — the benchmark for long-term, fixed-rate financing in commercial real estate — hovered near 4.7% in mid-June, up from 3.4% a year earlier.

“With the cost of money increasing, buyers will have to carefully examine what they are paying for properties,” Stoffers says. The good news is rising interest rates will lead to fewer first-time homebuyers, Stoffers adds, and increased occupancy and rent stabilization in the apartment market.

Effects on Borrowers

Rising interest rates will inevitably result in more conservative underwriting and reduce the amount of leverage available to borrowers, says Padilla of NorthMarq, but he emphasizes that higher capitalization rates usually coincide with changes in interest rates.

Although CMBS loan delinquencies are on the rise, according to the MBA, that alone isn't likely to bring about more conservative underwriting, Padilla says. “There is just a ton of capital out there that's looking to do mortgage loans, to buy real estate and everything in between,” Padilla says. “That kind of pressure to get the capital out will somewhat balance the slightly increasing delinquency performance.”

The largest loans are increasingly focused on fixed-rate financing, and lenders and intermediaries expect a vigorous business as borrowers convert from floating to fixed rates. Those conversions and continued high demand for acquisition financing could very well make 2004 another banner year in lending.

“Everybody we've talked to says they're expecting to hit or exceed their goals for the year, whether they're an intermediary or capital provider,” says Holliday's McMullin, “so we expect 2004 to be as good or better than 2003.”

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