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At first glance, the market for commercial real estate capital is in good shape. There’s strong demand for construction and acquisition financing, and there’s no shortage of capital sources interested in commercial real estate debt and equity. So why is it so challenging to get deals done? Despite strong demand and available capital, borrowers and lenders alike are finding roadblocks on the way to the closing table.

At a recent Bisnow conference on real estate finance and investment in Chicago, John Hofmann of KeyBank Real Estate Capital was asked to sum up the state of the market in a couple of words. His response: “Seeking stability.”

Co-panelists who represented a cross-section of debt and equity providers echoed Hofmann’s sentiment by describing the market as full of “uncertainty” and “choppiness.”

It’s an odd phase in the real estate cycle. There’s strong demand for construction and acquisition financing as well as refinancing, and plenty of capital to meet demand. The problem: making deals work for both borrowers and sources of capital.

What’s giving everyone the jitters?

Memories of the global recession and its aftermath are still fresh in lenders’ minds as they watch for signs of a slow-down. On top of that, banks and CMBS issuers are operating under new regulations, making them more selective.

Market fundamentals are a concern as well. In the multifamily sector, a great deal of new supply is coming on-line at a time when rent growth has flattened out and affordability has become a major issue. Some retail segments are feeling the pressure of competition from e-commerce. Office and industrial sectors appear solid but could turn quickly if the economy—now in its eighth year of growth—slows down.

Likewise, many borrowers are still recovering from losses they took a decade ago. They’re seeking stable debt and equity capital in an environment of rising interest rates and higher debt service coverage (DSC) requirements. They need to come up with more equity than before, and many lenders are insisting on recourse provisions.

Deals are getting done

The good news is that deals are still getting done. “Like a lot of banks, we have one foot on the brake and one foot on the gas,” Hofmann said. “We’re active across a full suite of products, but cautious about where we put our money.”

“This is an interesting year for refinancing,” Hofmann said. “Clients who, in the past, would have gone to CMBS are now trying to flush out other opportunities.” Borrowers are shying away from CMBS deals in part because of the restrictive nature of the covenants. Borrowers who may be stretching to make deals work at the outset want servicers who can help them get on more solid ground as conditions change, and CMBS deals don’t allow for that.

The CMBS market is also subject to volatility, which can disrupt deals before closing. “Last year, especially in the first quarter when there was a lot of volatility in CMBS spreads, we ended up taking a lot of deals onto our balance sheet,” Hofmann noted.

That added risk, plus the requirement that issuers retain a percentage of CMBS volume, has caused many CMBS lenders to exit the business. And the ones that remain aren’t offering the generous terms of a few years ago. Still, for long-term financing on a retail property in a secondary market, CMBS may be the only choice borrowers have.

Enter Private Capital

The construction loan market has also experienced dislocation in the past year, in part because new rules on banks’ capital reserve requirements limit the number of deals they can do. Construction lenders are also concerned that there could be a recession in the next three years that could leave speculative buildings without tenants, making takeout financing impossible. And while overbuilding isn’t a major concern, lenders are keeping an eye on the multi-family sector, where a lot of new supply is coming on line just as rents seem to have reached their peak.

As a result, banks are offering lower loan-to-cost (LTC) ratios on new construction deals, forcing developers to come up with additional equity. Hofmann noted that KeyBank Real Estate Capital is focusing its construction lending on existing developer clients, and on companies the bank serves in other areas. He’s also helping clients connect with mezzanine debt, bridge loans and equity financing from sources that often include private equity funds.

“We’re seeing a lot more private capital coming into construction finance in 2017,” Hofmann said. In the acquisition market, competition from foreign and institutional buyers has driven property prices to new highs, leaving little room for upside in buying core properties. Investors on the Bisnow panel said they are looking at more value-add opportunities, as well as bridge and mezzanine financing that offers similar yields and a similar risk profile.

Difficult but Doable

Whether with private capital or a combination of capital sources, properties are getting financed—it’s just more complicated these days. Most of the Bisnow panelists expect their deal flow to hold steady throughout 2017.

Lender caution may be better for borrowers as well. If fewer construction projects are coming out of the ground, the ones that do may lease up more quickly. Deals with solid underwriting are less likely to need to be worked out down the road. And the relationships developed during this time of relative instability will pay off for lenders and borrowers over the longer term.

Key Takeaways

  • Banks are focusing construction loan volume on existing relationships and well-capitalized developers.
  • Borrowers seeking flexibility are shying away from CMBS due to market volatility and restrictive covenants.
  • As properties surpass previous peak values, investors focus on ‘value-add’ opportunities that may include equity financing.

To learn more, contact:
John Hofmann, VP, Senior Mortgage Banker, KeyBank Real Estate Capital at 312-730-2745 or

To view more financial insights and the latest news and information from Key, visit