Wall Street aids in real estate recovery.

Capital markets accessed via Wall Street have helped to solve a liquidity crunch for the commercial real state industry during the past five years. Some observers, however, have questioned whether Wall Street will continue to serve as a competitive source of capital through the remainder of the decade.

Not only is there plentiful supply of real estate money from Wall Street, but there appear to be more investment banks wanting to get into the business. These investment banks are willing to risk their own capital to create large pools of mortgages that they can sell in the secondary market, and thereby make tremendous profits from the spreads that they realize through the resale of these mortgages.

As most traditional sources of real estate capital dried up about five years ago, Real Estate Investment Trusts (REITs), conduits (pools of money organized by investment bankers) and direct lending by the investment banks evolved as a new source of capital for real estate borrowers. Without this capital injection from Wall Street, the recovery that has begun in many real estate markets would not otherwise be happening now.

Sam Zell, considered by many as one of the most savvy and contrarian real estate investors in the country, believes that the future of real estate ownership is in the consolidation of assets into large institutional pools. Zell has raised over $1 billion of equity and debt from the capital markets via Wall Street. and he has invested several hundred million dollars in Southern California over the last 18 months.

Nearly every major institutional lender is back in the market. Life insurance companies, pension funds, commercial banks and credit companies are all lending on real estate-backed assets. Steve Graves, second vice president of The Principal Financial Group, commented: "We are having a stupendous year. Our year-to-date loan volume is approximately $2.3 billion, and we could reach $3 billion by year end."

Commercial banks are again considering new construction financing for projects with the proper sponsorship and pre-leasing. Interest rates for new construction deals that are well-underwritten are less than 200 basis points over the London Interbank Offered Rate (LIBOR). Well-underwritten permanent loans can be fixed at about 100 basis points over LIBOR. Credit companies - many of whom never really left the market - are finding it hard to get their fair share of loans in the marketplace without new and creative programs. "We must continue to look for a better mouse trap, or we will be left in the dust," conceded Michael Goldsmith, group president for Heller Financial in Chicago. "However, we are able to do a lot of deals that fall below the radar screen of the typical lender."

The big void in the real estate finance market is loans for "B" quality assets in the $1-million- to $15-million- range that were once made by savings and loan institutions. These type of loans are not attractive to the large institutional lenders due to the size of the loan requests, the age and the general condition of the properties, as well as other factors that remove them from the "A" institutional-quality asset class. But, this is where investment banks can step in. They are "cash flow" lenders who are not as concerned with the quality of the assets as they are with the ability for these properties to provide cash flow. The smaller size of the individual assets are not a detriment, but actually an advantage in that the rating agencies don't like to see any single asset being greater than 8% to 10% of a pool. Therefore, in a $200 million pool, the largest single asset shouldn't be larger than $16 million to $20 million. This gives the pool greater diversification, and therefore more stability should one of the loans go bad.

Investment banks want more of the market, explained Tom Flexner, managing director of Bear Stearns Mortgage Capital. "Wall Street has become a "bridge" lender, a stepping stone to do bank business. Borrowers, such as REITs can now get senior, unsecured debt ratings as an alternative to the mortgage market. Virtually every type of product can be financed through Wall Street, except for long-term, non-investment-grade leases." Every major investment bank is in the market trying to originate commercial mortgage pools in order to realize the leverage and tremendous profits obtained from selling these mortgages in the secondary market.

Though most of the investment banks act as conduits in coordinating loans of regional and national mortgage brokerage companies, some investment banks will allow borrowers to go directly to them. Nomura Securities is perhaps most recognized as the investment bank with the track record for using its own balance sheet to underwrite deals, and provide direct access to their real estate underwriting group. Kathy Corton, director of Nomura Asset Capital Group, whose responsibilities include overseeing "Nomura Direct," commented that, "our in-house staff allows us to give quick responses to borrowers seeking to access Nomura capital. We have been very happy with the response that Nomura Direct has received from the marketplace, and we continue to seek new investment opportunities." Nomura has been one of the main debt and equity sources to the real estate industry for the last 3 years, providing approximately $5 billion of debt and equity capital for the real estate markets.

Though Nomura may have led the way for investment banks to use their own balance sheet to underwrite commercial real estate loans in recent years, there is now a tremendous amount of competition. Arvind Bajaj, vice president of Morgan Stanley Realty, explained that "committing your balance sheet today is much more important than it was 18 to 24 months ago." Morgan Stanley has committed to over $2 billion of business in 1995 as principal, and it plans to debut a $300 million pool this coming January to sell to the secondary market. Other investment banks that have been willing to commit their own capital in order to guarantee obtaining their fair share of the lucrative Commercial Mortgage-Backed Security (CMBS) market include: Lehman Bros., Bear Stearns, Donaldson, Lufkin & Jenrette (DLJ), Merrill Lynch, CS First Boston, and Goldman Sachs & Co.

Though the sale of CMBS in 1995 is slightly behind that for the same period in 1994 ($13.8 billion vs. $9.4 billion through September, according to Commercial Mortgage Alert), there appears to be no shortage of an appetite from the secondary market for well-structured CMBS. The secondary mortgage market has especially grown for non-rated "B" piece buyers. The "B" pieces are the higher-yielding non-investment grade tranches, or components, of a transaction that are typically more difficult to sell. New funds are being created, however, especially for investments in these "B" tranches. "The market is much deeper and more complex today that it use to be," observed Bill Powers managing director of PIMCO, a $70 billion money management firm and buyer of "B" tranches. "Bond managers need to do a lot more due diligence than they have had to in the past."

While some money managers may be wary of certain CMBS products, this market will continue to grow so long as investment banks can continue to profit by reselling real estate loans to a liquid secondary market.

DAVID SONNENBLICK IS MANAGING DIRECTOR OF SONNENBLICK GOLDMAN COMPANY IN LOS ANGELES, AND WILL BE A MODERATOR AT UCLA's UPCOMING 1995 ANNUAL REAL ESTATE FINANCE CONFERENCE.