January 14, 2021
By Dennis Kaiser
KeyBank’s debt capital markets lending team remains active across the commercial real estate financing spectrum encompassing multifamily (affordable and market rate), seniors and commercial property types. With access to a full suite of permanent mortgage products including Fannie, Freddie, FHA, CMBS, life company and bridge loans, the bank has remained an active commercial real estate lender. Connect Media sat down recently with KeyBank’s Matt Ruark, head of commercial mortgage production, Joe DeRoy, head of the bank’s CMBS program, and John Hofmann, who leads the commercial mortgage production team, to get their insights on financing opportunities in a disruptive time as the market is being shaped by a global health pandemic.
The trio offered a deep-dive into such topics as how the current downturn compares and contrasts to the Great Financial Crisis, the asset types that are rising in favor, the role of CMBS, the best strategies for coordinating capital, and why the current environment is ripe for relationship lending.
The consensus among these veterans is that navigating the debt markets in this turbulent time requires an experienced lending partner and the ability to coordinate and arrange financings across numerous capital sources. KeyBank, a Cleveland, OH regional bank with $170 billion in assets and a $15 billion commercial real estate portfolio remains nimble in its one-stop approach when coordinating an overall capital strategy with multiple options for clients.
Financing Opportunities in Covid Era
The disruption caused by the COVID-19 pandemic is real, notes Ruark. But that doesn’t mean opportunities to borrow capital for the right project in the right market have disappeared. In fact, they see opportunities across the CRE asset classes from multifamily, office, industrial, self-storage and even for some retail properties. Ruark said, “We find the right execution for a borrower. As an active commercial real estate lender, we know what the market will bear, and can provide certainty of execution.”
Compared to what the CRE market went through in 2008-2010, 2020 is completely different. In the previous downturn, it was a lengthy recovery process with numerous rallies, setbacks and small recoveries in the ensuing years. “The 2020 pandemic downturn hit hard creating a market dislocation that hasn’t been experienced in prior recessions. However, the real estate debt capital markets sector has held up. Mortgages and real estate are still relatively attractive when searching for yield. Real estate is certainly a more attractive place for capital than the last downturn,” according to Ruark.
“The market hasn’t been frozen for a prolonged length of time like it was in the previous recession and we’ve seen a quick snapback since the early days of the pandemic,” said Ruark. “Companies are making educated decisions now versus enduring prolonged uncertainty, like happened before. There is capital in the system and tailwinds are pushing the commercial real estate forward.”
“While there may have been a bit of a pause, the market is back up with few lingering effects. There’s an appetite for mortgage loans in the multifamily and commercial CRE segments, though hospitality assets are not finding favor with lenders and retail is highly scrutinized now too,” points out DeRoy.
In the pre-COVID-19 environment, a number of drivers were already affecting the market. “I think what you’re going to look back and see is that the downturn associated with the pandemic was not a dislocation of markets, but an acceleration of trends,” said Ruark. “There were different trends happening in the marketplace that people were talking about like, what’s the future of retail; what are office needs going to be and what’s going to happen with this continued acceleration of construction trends associated with multifamily,” he said.
The uncertainty in the current commercial real estate market clearly calls into question the future performance of certain property types, to be sure. DeRoy points out there will be haves and have nots. For instance, the post-Covid space requirements for office is still being determined. The future urban HQ office may be less dense to accommodate social distancing requirements or remote work preferences. While suburban offices, with their typically larger footprints, may be favored because they offer the flexibility to be socially distanced.
Return of CMBS
All lending markets were materially impacted as the COVID-19 pandemic hit in March and April of 2020 due to market illiquidity and a dislocation of credit spreads. DeRoy notes the disruption made it important to have a deep knowledge of capital markets and how they function when stressed. “The GSE’s were the first debt capital markets products to stabilize due to their inclusion in government-enacted liquidity bases via the Federal Reserve, a source of capital that wasn’t initial available to private lenders, the CMBS market or others,” said DeRoy.
“While GSE credit spreads were the first to retrace the market widening, other lending sources, including CMBS followed suit when the Fed stepped in to produce a backstop through their inclusion in TALF, DeRoy said, and quickly preserved the markets’ illiquidity and borrowing rates.”
While it was true that CMBS transactions had been on the sidelines from late March through early May, $14 billion of conduit and $12 billion of single borrower issuance has hit the market since. While most of the mortgage loans from restarted conduit issuance were originated pre-pandemic, more than 70% of the collateral in recently issued conduit CMBS is newly originated with updated enhancements. In addition, CMBS credit spreads have retraced all the widening that occurred during the pandemic and have shown stability throughout the fourth-quarter of 2020, notes DeRoy.
Investor sentiment in CMBS bonds has been strong, especially with limited new supply and a tighter credit box. “The magnified view from a credit perspective is lenders are leaning on office, industrial, self-storage and multifamily asset classes. Since the multifamily space is dominated by Agencies, lenders are leaning on commercial assets, to round out their pools. However, with the recent changes to Agency caps and mission criteria, we are hoping to see increased CMBS opportunities from the multifamily segment into 2021,” points out DeRoy.
DeRoy added, “The CMBS market saw continued momentum in the second half of 2020, and I expect it to continue in 2021. There are two sides of the private label, non-agency CMBS market. You have the conduit space which includes a more granular loan profile and then you have the single-asset / single-borrower (SASB) space.”
Looking at the SASB side of the industry, it is a private placement that’s direct to institutional investors and is typically comprised of portfolio loans or highly institutional property types to highly institutional, or capable sponsorship. DeRoy explained that profile of loan, both on the short-term floating rate, and the 7- and 10-year permanent fixed rate is an attractive financing vehicle because loan size can range from $200 million to $2 billion, in all different forms and property types. Investors have a proficiency and a true understanding of that asset class.
A SASB deal requires diligence to one borrower and one asset or portfolio of like assets, notes DeRoy. On a diversified portfolio of conduit loans, there’s a more granular loan profile that requires a heavier lift on the investor diligence side. For that reason, SASBs have been a preferred lending vehicle for large CMBS loans for the last 3 to 5 years, which will be magnified into 2021 considering the recent challenges of the bank and life company syndication model.
DeRoy notes an example of a recent execution, Progress Park, an industrial portfolio in Wilmington, Ohio. KeyBank secured a $17.6 million fixed-rate CMBS loan for I3 Investors, an Indianapolis-based private real estate investment firm, to acquire the assets.
Built in 1990, Progress Park is a 615,000-square-foot, warehouse and distribution facility. The largest tenants are G&J Pepsi-Cola Bottlers and Greencore USA.
The loan is structured with a 10-year term with a three-year, interest-only period followed by a 30-year amortization schedule.
Environment Ripe for Relationship Lending
The current market in which uncertainty and disruption are prevalent is an environment that is ripe for a relationship lending strategy. Hofmann, whose nationwide team handles transactions across all asset classes for multiple capital sources, indicates today’s approach is more about relationships than ever before.
Hofmann said, “relationships are the cornerstone of our business. We take our relationship borrowers from a construction loan on our balance sheet to a permanent mortgage where we retain the servicing for the life of the loan, which is very different than many of our competitors.”
KeyBank has one of the largest servicing portfolios in the CMBS area, which naturally opens the door to closer relationships today. “The value-add we bring in this market with so much disruption is staying with the client for the life of the loan. We help them navigate servicing issues that may arise during the current climate,” he said.
The leaders agree there is still capital available in the system despite the larger market disruption due to COVID. The decision for lenders comes down to the asset class, property performance metrics and the ability for a sponsor to execute on a business plan. In general, the low interest rate environment has helped keep values stable and borrowing rates low.
KeyBank’s foundational relationship lending model places a high value on the sponsor. It is an approach that they indicate has proven to be a good strategy, especially when there’s the level of stress in the CRE market that is evident today. Hofmann said, “We believe that our best sponsors are going to be defined through these cycles and through these ups and downs. We bet on the sponsor, remain loan product agnostic and that has proven to be a good strategy.”
The relationship lending model finds the best deals and creates the optimal funding vehicle for borrowers. In challenging times like today, lenders need to be there for borrowers and have their best interests at heart. Hofmann concludes saying, “people remember who over-promised and underdelivered. In these times of uncertainty, borrowers want to work with a lender that understands the relationship-first approach and values certainty of execution.”
For comments, questions or concerns, please contact Dennis Kaiser