{meta_title}

Cyclical Pull: Commercial Borrowers Tilt to Fixed

May 2007

Current competitive market conditions are allowing borrowers of commercial real-estate to shop for lower, fixed rate mortgages that allow for great flexibility in payment structures and preserve working capital.

As reported by American Banker in its April 2007 issue, in recent quarters, market observers note that bankers are making more fixed-rate commercial loans in response to two factors: changing borrower tastes and intense competition for credit. The trend, which could put pressure on lending firms' net interest margins for months, reportedly is concentrated in small-business loans and commercial real estate. Sterling Bancshares Inc. Chairman and CEO J. Downey Bridgwater observes that the migration of commercial credit to more fixed-rate offerings is occurring "across the industry, and it's a basic component of the competition." Some bankers are taking action to ease the pricing pressure by altering the benchmark off of which they price certain loans.

“Over the past several years, the capital and spatial markets have been somewhat decoupled. That is, real estate fundamentals languished at the same time as capital flows to the sector increased, comments James R. DeLisle, Ph.D, of the Runstad Center for Real Estate Studies, University of Washington. “The end result was a strong bull run in terms of value gains driven in large part by a willingness of investors to accept lower yields. This acceptance of lower yields was not isolated to real estate, although it was unusual in the sense that it reflected a repricing of the asset class without the promise of higher returns from an anticipated up tick in the market,” he said.

Over the past six to nine months, according to DeLisle, this situation has changed somewhat as the improving economy has begun to stimulate demand and bring the spatial markets back in line with a more balanced supply-demand mix. Despite this improvement, the tremendous build-up in demand for assets has led to even more aggressive pricing. In some markets, this surplus of capital has led to increased construction, especially in attractive products such as condominiums, mixed-use developments, and life-style centers.

“While there does not appear to be any danger of a widespread surge in construction that could lead to erosion in the market balance, the real estate industry appears to be entering an 'interesting‘ period in which fundamentals will play an increasingly important role in determining the winners and losers,” DeLisle said “Indeed, it is likely that a greater appreciation for the drivers of value and the ability to create and capture value will become more important to players in the real estate industry.”

A surplus of capital chasing limited opportunities continues to characterize the mortgage market, much like the real estate equity market, and is due to strong appreciation in commercial property values, strong transaction volume, and low interest rates. Due to this competition, lenders have become more aggressive and flexible, and luckily delinquency and foreclosure rates have continued to remain below long-term averages, however, the rise of structured financing and unsecured debts are of concern. As spreads remain attractive, and borrowers are not deterred with rising costs of capital, commercial mortgage brokerage services should experience another strong year.