deals with a cautious mindset
The speculative nature of construction and development projects makes some commercial real estate lenders
wary, especially at a time when a market downturn seems imminent. Recent data shows mixed interest for these
types of projects.
Commercial and multifamily construction starts increased in 11 of the top 20 U.S. markets, as measured by dollar
volume, during the first six months of 2018, according to Dodge Data & Analytics. The nationwide dollar volume
of these construction starts, however, was down 1 percent year over year.
Scotsman Guide spoke with Lisa Pendergast, executive director of the CRE Finance Council, for insight into lender
and investor mindsets for ground-up construction deals.
Are lenders being more cautious about issuing construction loans in this portion of the commercial
real estate cycle?
I recently did a panel where I asked each of the panelists — and these were all folks who participate in commercial
real estate lending and investing — I asked them about where they thought [interest] rates were going be, where
they thought the equity market was going to be, whether they thought it was time to really rein in risk, and I have
to say they were all of the view that the market will remain relatively benign for commercial real estate.
I’m not putting rose-colored glasses on. I’m just suggesting that there has been a very slow process moving
[property values] higher. I think there is a point where valuations are considered by both buyers and sellers to
be at levels where caution is advised. So, to the extent that you’re developing new assets in the marketplace,
I think there’s a strong sense that it needs to be in the right market, and if you choose the wrong market in
today’s extended cycle, there is significant risk.
Which U.S. markets have high demand for construction and associated financing needs at this time?
The strength lies in those markets where we’re seeing strong tech trends. Clearly, all of Northern California is
probably a decent place and yet, in Los Angeles, you’re starting to see an amazing amount of new construction.
The question there is, is that a market that can withstand [a downturn]?
I think what’s good is that, if you think about who’s lending in construction, it’s the regulated financial
institutions. It’s the banks. Even some life companies are starting to do construction loans. … You also
have all these alternative lenders, many of whom joined the space, in part, to take advantage of things like
HVCRE (high-volatility commercial real estate) and its negative impact on how much construction lending banks
Are there property sectors that are seeing more of a construction boom?
Multifamily and industrial are really, really safe plays in many markets, although I think we are reaching a point
in certain markets where multifamily would be approached with some caution. For example, here in Manhattan,
there has been a lot of multifamily development. It’s not, however, like these [deals] aren’t clearing, if given some
short-term incentives to do so — a month’s free rent or whatever it might be.
I think industrial … will continue to be strong. And the issue there is not just new construction. It’s redevelopment on the industrial side. We’re seeing a significant amount of that, and I suspect that will continue. Walmart
has just started to focus on industrial [investments] around major cities. At some point, with any sector that’s
hot, you’re supposed to keep your antennae up and be somewhat cautious.
Are land-acquisition costs becoming too expensive and holding back some construction projects?
Land-acquisition costs, more than anything else, are a very, very market-specific discussion. … When you talk
about acquisition costs, the thing is, you’re buying the underlying dirt, and yet when that asset gets up and
running — when you get your [building] permits — what’s the market going to look like then? Are you going to
be unveiling this new asset in a market that’s starting to turn? It’s really difficult with talks of tariffs.
A lot of buyers out there are really going to look into where is the upside in this land acquisition? And if you’re
a lender, you should be thinking along those same lines as well. … It’s clear that at this point, your construction
costs and your values on the finished product really need to be fairly conservative for both lenders as well as
borrowers deciding to move forward. n
Neil Pierson is editor of Scotsman Guide Commercial Edition.
Reach him at (800) 297-6061 or firstname.lastname@example.org.
Lisa Pendergast is executive director of the CRE Finance Council, where
she has served for nine years on the
organization’s board of governors
and as its 2010-11 president. Pendergast has published several articles
and reports on various aspects of
the commercial mortgage-backed
securities (CMBS) market that have
appeared in industry handbooks
and academic journals. She previously worked with Jeffries LLC as a
managing director and head of CMBS
strategy and risk, and with the Royal
Bank of Scotland as a managing
director of fixed-income strategies.
Reach Pendergast at (646) 884-7570
Executive director, CRE Finance Council
By Neil Pierson