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Bouncing back.

The commercial real estate market is slowly healing and actually reviving in certain markets. With each passing month, the evidence is mounting that the flow of funds is returning to real estate investments, as investors see that a bottom has been hit and good values are there for the taking. Banks have even begun loosening their purse strings in recent months after a long period of shunning even the thought of lending on commercial real estate. This is a somewhat different view than what was conveyed as recently as a year ago. But there's no denying the growing sparks of life--particularly in apartment lending and in the next wave of recovering markets that went down shortly after the oil patch sunk into deep recession. Texas is back, but now increasingly so is Arizona--perhaps the next bargain hunters' real estate paradise.

Del Ellis, senior vice president, Bank of America Arizona, in Phoenix, says that portions of the Arizona market "have come back" and that apartments are attracting strong investor interest. Ellis says, "there are a lot of buyers and a lot of money available to make those purchases." He adds that it's "not new construction as much as acquisitions" where the market tends to be the hottest.

We asked Ellis what was the most encouraging sign he'd seen to date that indicates a return to health in his markets. He says that in the Arizona marketplace, it's the "renewed interest by investors and developers." He adds, "We are seeing more and more activity." Ellis says that the rediscovery of the Texas commercial real estate markets in recent years by investors sensing the bottom had been hit, is parallel to what is happening now in Arizona. Ellis says that Arizona real estate investors "feel the opportunity is right and the price is right" and the properties available represent better investments than the other opportunities out there. In general, Ellis says, "We have turned the corner. It's going to be slow--it's not going to be a boom--but we have turned the corner."

We tried to get a sense of whether commercial mortgage bankers feel they've gotten much help out of the federal government. We specifically asked if President Clinton deserved any credit for the reawakening of the market. Ellis says Clinton can't take any credit for any policy moves he's intentionally undertaken. But "just by happenstance" the fact that interest rates have stayed down during his term has helped commercial real estate. Rates have stayed down, Ellis says, because people are waiting and hoping for a real deficit reduction package that makes sense to the market and succeeds in keeping rates down in the future. Also contributing to lower commercial mortgage rates has been reduced demand for those funds, he says.

In talking about the commercial market's emergence from tough times, we also tried to find out what, in retrospect, was the single most damaging thing that occurred in the commercial real estate sector in the last 10 years. Ellis says that it really began with the 1981 Economic Recovery Tax Act and the tax incentives it created to build and invest in commercial real estate. But he says the really damaging waves of tax-related investments in Arizona came in the 1983-1986 period. He says contrary to the widely held view that it was the reversal of those tax policies in 1986 that caused the most damage, in his view, it was the irrational investments made purely on the basis of those tax incentives.

As to where the funds are coming from today to finance the newest wave of commercial real estate acquisitions, Ellis says that the most active source of new funds has been real estate investment trust (REITs). But, Ellis adds, "I'm seeing a lot of indications in the banking industry--not in California, but in the rest of the country--that banks are making funds more available to commercial real estate." And as far as the earlier problem with bank examiners forcing banks to aggressively write down the value of their real estate holdings, Ellis says, "I don't think it's been solved. But more and more, examiners have started--they haven't completely |come around~--but they've started getting more realistic about commercial real estate."

Another mortgage banker who is also a president of a bank holding company, says it comes down to the fact that, "Examiners have a fear of commercial real estate." Barry Slatt, president of Barry S. Slatt Mortgage Co., Burlingame, California, says nine out of ten regulators would say banks shouldn't have such assets in their portfolios. Slatt adds that "regulators don't really understand real estate, so the easiest thing to do is just require banks to set up reserves" to cover possible losses in asset value. But Slatt says the regulators are in a tough spot too. They are being pressured by the Congress to stay tough on banks or get even tougher now that banks are starting to step up their commercial real estate lending because of attractive spreads. But, he says, of the new investment in real estate, "banks are going to get crucified for it." Slatt says the regulators will say the values aren't there and require reserves against the loans.

We asked Slatt what one or two things Congress or federal regulators could do to help improve commercial real estate markets. He said a current REIT-related tax provision in the budget package moving through Congress would help pension funds invest more in commercial property if approved. Also, he adds, getting the bank regulators to lighten up on underwriting requirements and improve the way they value commercial real estate on the books of banks. Slatt says origination activity is heating up in his markets. At the halfway mark this year, his firm's production totalled $80 million. That compares favorably with the $115 million total for 1992 and the just shy of $100 million done in 1991. Of the $80 million, roughly $25 million was done in markets in the Northwest--particularly Seattle and other parts of Washington and Oregon.

But the balance was done in California, split between southern and northern parts of the state. Slatt says that lenders now are "very cautious in California, probably more cautious than anywhere else in the country." Ninety percent of Slatt's production so far this year has been loans made by life insurance companies. The lenders have been predominantly small- to mid-sized life companies, but one of his loans was done with Pru Express for a PACE store in Chicago.

Slatt says that a lot of life companies have been showing strong interest in the Northwest to bring more geographic diversity to their portfolios. Of all suppliers of funds to commercial real estate, Slatt says the life companies now are most active, from his perspective. He says the spreads available from real estate are helping insurance companies keep the returns up for their portfolios. He says that in California, thrifts are still doing a lot of apartment lending with variable-rate financing, so he hasn't experienced the strong activity in that area from his life company investors. Slatt's firm has done more on retail and industrial-type properties, but he adds that his experience doesn't necessarily mirror what's happening in other parts of the country where thrifts are not as active in multifamily.

On the most damaging development in the last decade for the commercial market, Slatt says it was the teaming up of big national development firms with joint venture financing partners that didn't have the same long-term concerns about preserving stability in local home markets as smaller local developers. That development, along with the abundance of capital being churned out looking for high returns, simply flooded most major markets with serious overbuilding. Slatt says the most encouraging sign for commercial real estate he's seen is the willingness of today's borrowers to accept the mortgage terms that lenders are willing to offer. He says now borrowers are putting real cash into a deal and taking shorter amortization, so there's more principal build-up early on. He adds that we are "seeing a lot better deals for institutional investors than anything they could get since the late-1960s."
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Title Annotation:commercial real estate market recovery
Author:Hewitt, Janet Reilly
Publication:Mortgage Banking
Date:Jul 1, 1993
Previous Article:Float loss.
Next Article:Multifamily money.

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