Commercial Mortgage Credit

Commercial mortgage credit availability presently and in the foreseeable future will still be restrictive and limited.  It is estimated that over a trillion dollars worth of commercial mortgages in the United States will become due in 2012 to 2013.  This  represents over 25% of all commercial mortgages outstanding in the US.  Unfortunately, many of these commercial mortgages were underwritten and subsequently financed at 5 or 6 percent cap rates.  Cap rates have an inverse relationship with values associated with commercial properties.  For example, if the gross cash flow of a property is $100,000 per year, then using a 5 or 6 percent cap rate would result in a value of $2mm or 1.66mm. As a result, many lenders before the financial collapse of 2008 and 2009  thought that commercial mortgages were adequately collateralized.

When Lehman Brothers filed for bankruptcy protection, everything changed overnight.    Financial markets were thrown into a spiralling  vortex.   Commercial lending abruptly collapsed and cap rates rose as much as 50%.  The net effect was that commercial value were significantly reduced.  Taking the above-mentioned example, a cap rate of 7.5 or 9 percent would result in a value reduction to 1.33mm or 1.11mm.  Simply put, equity in most commercial properties eroded dramatically  in a very short period.  Commercial lenders were now stuck with commercial loans that were underwater or with loan to values exceeding 100%.  This, in effect, caused the Feds and regulators to require more reserve and capital requirements on lending institutions. 

This pressure caused lending institutions and banks to require more collateral or equity from those holding commercial mortgages.  Unfortunately, many of these developers were too leverage in other projects or simply did not have the cash in order to pay loans down to more acceptable levels.  The results have been catastrophic to the commercial industry and property values.  With insufficient reductions in loan to values, many commercial lenders have been forced to call the loan on commercial mortgages.  This has placed evenmore downward pressure on overall values of commercial properties.  It has become cyclical.  As commercial values reduce, more loans are called by the banks.

In summary, commercial institutions and banks will require higher equity contributions for commercial mortgages in the next few years.  It will be many more years before investor cap rates decline which will intrinsically result in higher values and reduced LTVs.  In short, commercial borrowers can expect to equity requirements of 30 to 40 percent in lieu of traditional 20 percent requirements.

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