A look ahead at real estate financing.

In the first half of 1998, the real estate market in New York City and in markets across the country continued to experience increases in rates and occupancy that seemed unimaginable just one year ago. Asking rents have soared as available space dwindles, new construction of both residential and commercial properties has begun, and commitments to new developments by financial partners have reached levels approaching those in the mid 1980's.

It's never easy to fully understand the economic cycles that determine fluctuations in the real estate market, or any other market for that matter. But it is possible to see that certain conditions contribute to the health and well-being of the real estate industry. And while it is certainly not the only factor that is contributing to the growth of real estate, the availability of financing at attractive rates certainly plays a significant role. The question we all ask ourselves is, will the availability of financing continue?

One indication that bodes well for the future availability of real estate financing is the development of Commercial Mortgage Backed Securities (CMBS). Through CMBS, traditional mortgage providers become a conduit to larger sources of capital than would otherwise be available through the securitization of their existing mortgage portfolios and the origination of mortgages specifically for securitization. In 1997, $44 billion of CMBS were issued; in 1998, the new issue market is expected to grow beyond $70 billion.

The CMBS market offers sufficient capital at attractive rates for real estate projects. Key questions to be answered in the second half of 1998 are: how will rating agencies, investment bankers and servicers handle the continued explosive growth? Secondly, will there be enough CMBS investor demand to keep pace with the volume of new issues? As the year draws to a close, these answers will shape the course of CMBS issuance in 1999.

This is not to say that lenders should take a less conservative approach to financing development projects. Lessons of the real estate crash of the early '90's should never be overlooked. In fact, the securitization of mortgage portfolios requires mortgage conduits to adhere to strict standards and credit criteria when underwriting projects. Maintaining standards in a competitive market will be one of the key challenges in the second half of 1998. On the contrary, the temptation is for lenders to relax their standards to remain competitive, and as a result, consistency in underwriting standards is not easily maintained. Industry vigilance is necessary so that rating agency standards are not ignored and loans can be systematically sized and qualitatively reviewed.

Other lending businesses, such as banks and insurance companies, have regulators, including accountants who set industry standards and rules. In the world of securitized lending, however, credit rating agencies "police" the industry. It is essential for the rating agencies to monitor themselves, since they have a large impact on the credibility of lenders, the quality of loans and the future of the industry.

So, as the CMBS market develops and continues to make available competitively priced financing, there needs to be a consistent and diligent system of checks and balances throughout the industry for the good times to continue into 1999.

(Daniel P. Kenny is President of VB Realty Capital, a commercial mortgage division of Vereinsbank America Inc. VB Realty has a commercial mortgage conduit program for the purpose of securitization. The firm is strongly capitalized and focuses on providing nationwide mortgages in the $2 million to $30 million range.)