COVER STORY, FEBRUARY 2006

BANKS AND LENDING

The lending climate in Texas continues to be active. An extremely competitive environment, an abundance of capital and a pro-active business climate, among other advantages, have made the state nationally attractive to major lenders. Deals are being made in all markets and all property types with the major cities of Dallas, Houston, Austin and San Antonio — as well as some of the larger secondary markets — doing very well. Texas Real Estate Business recently spoke with several industry experts to find out the latest trends in real estate finance and what to expect in 2006.

Lending Climate

The lending climate in Texas appears to be bright for 2006.

“There are a lot of deals being made in Texas and throughout the country right now,” says Charlie Singletary, principal with Austin, Texas-based Torreón Capital. “The real opportunities in Texas are in the primary and larger secondary markets.”

“Across all property types, we're seeing consistent growth in the demand for both acquisition financing and replacement financing in Texas,” says Paul Geyer, head of Prudential Mortgage Capital Company's Dallas office. “Just as in other regions in the country, increased competition to acquire properties is forcing lenders to become more flexible and create new products. That's leading to some interesting and creative loan structures, like construction permanent loans, mezzanine loans and higher-leveraged structured loans.”

This increased competition, along with Texas' business and living advantages, lead many to believe that the growth will continue. “Texas has a very attractive cost of living, an abundance of natural resources, an educated workforce, a pro-active business climate and a good university system,” says Rick Harsch, senior vice president for KeyBank Real Estate Capital. “Those are going to continue to attract business.”

Popular Loan Products

As rates continue to trend up, borrowers are looking for fixed-rate financing, according to Harsch. “The loan products where people can jump in and their projects stabilize, or they can lock in a fixed rate, are very attractive,” he says.

Matt Franke, vice president with Houston-based Q10 Kinghorn, Driver, Hough & Company, agrees. “Long-term fixed rate financing is particularly attractive right now due to the sustained increase in LIBOR yields during the last 18 months, especially since the 10-year treasury yield has remained relatively low in comparison,” Franke says. “Many of our clients have chosen to lock in their interest rates for 15 or even 20 years.”

Doug Esteves, senior vice president with USA Capital, sees demand for two other types of loans: residential land acquisition and development and   income-producing commercial properties. “Residential land acquisition and development loans are not a favorite type of loan for most banks because they require different and generally higher loan reserve requirements than for income-producing properties,” Esteves says. “For banks, land loans also are harder to sell off to SBA or other markets. They prefer to do things with predictable income, and land never has that.”            

Latest Trends

Fierce competition and the abundance of capital are causing Texas lenders to be more quick on their feet.

“Because of the abundance of capital in the marketplace and the compression of margins, you have to be quick to deliver or look at structuring or make it up in a different way, whether with advisory services or delivering mezz or equity,” Harsch says.

Esteves agrees. “The need for fast, flexible capital sources grows exponentially in highly active markets,” he says.

To meet the needs of today's borrowers, lenders are being more creative with their loan products as well. “As short-term rates have risen, we have seen several borrowers looking for a loan that combines the features of construction loans along with much longer term funds (kind of a construction/ permanent loan) versus the typical mini-perm, which banks have historically provided,” Geyer says.

Ground-up deals also have become popular during the past 12 months, according to Singletary. “With purchase cap rates low on existing product, ground-up development deals have much more upside potential,” he says. “In-fill repositionings will continue to play a significant role in the real estate finance/equity mix in 2006 as well. However, if the cap rates remain low, these deals will become harder and harder to find. But, they will be there.”

Tenant-in-common (TIC) groups   have been playing a big part in Texas real estate financing. “Clearly, one of the biggest trends has been the rapid increase in financing opportunities for TIC groups, which have been aggressively purchasing and financing institutional quality commercial real estate assets since the IRS released its favorable Revenue Procedure in 2002,” Franke says. “This procedure, 2002-22, has made it easier for 1031 exchange investors to pool their funds and purchase larger, higher quality assets than they would be able to individually.”

What's Hot, What's Not

Deals are being made in all of Texas' major markets. “[Dallas, Austin, Houston and San Antonio] are growing outward and inward,” Singletary says. “Developers are doing in-fill projects in the larger cities and projects of all types in the suburbs.”

Austin, in particular, is a city to watch in 2006. “Austin is on everyone's radar scope in terms of multifamily, retail and office,” Harsch says. “Retail is strong in all markets, but with a focus on tenants instead of quality. San Antonio's retail and housing also is very strong.”

While Franke agrees that the major markets are strong, he also notes the activity taking place in some of Texas' smaller cities. “It's interesting that we've seen significant capital going into secondary markets such as Lufkin, Waco and Tyler,” he says. “I expect continued activity in South Texas cities such as Laredo and McAllen, which continue to grow rapidly.”

Geyer agrees. “In smaller, tertiary markets, we have seen demand coming from retail and multifamily,” he says.

Though none of Texas' major cities can be classified as struggling, some product types in certain markets aren't faring as well as in others. “The Dallas multifamily market is somewhat flat but appears to be trending upward,” Harsch says. “Houston multifamily was at historically high vacancies, but the effect of both hurricanes have eliminated that high vacancy. I don't know that any product type is struggling. I think the low rates and the abundance of capital have kept everybody in play.”

“There are certain sectors and submarkets that are weaker than others, such as Dallas' central business district office market,” Franke says.

Predictions

In an increasingly competitive and aggressive environment, developers and lenders will be more cautious with their decisions in 2006.

“Look for more private capital placement because banks will be more cautious as interest rates rise, land prices increase and the housing market cools,” Esteves says. “Banks will still do deals, but not as aggressively as they have in the past.”

Singletary agrees. “In 2006, deals will not be made for the sake of making deals,” he says. “Developers and lenders will be looking much closer at the challenges and opportunities of each deal and making their decisions accordingly.”

As developers and lenders deal with these challenges, borrowers will be able to reap the benefits. “I predict that an increasing number of lenders entering the market will lead to even more concessions given to borrowers as lenders attempt to gain market share,” Franke says. “The biggest factor affecting Texas real estate financing is the large pool of lending capital chasing a much smaller pool of actual lending opportunities. Lenders have become increasingly aggressive and competitive in their attempts to win transactions. It's definitely a borrower's market.”

“Borrowers will continue to benefit from the depth of talented real estate developers and investors that we have, the companies interested in Texas and the number of lenders providing capital,” Geyer says.

The lending environment in Texas is strong, and due to the state's many advantages, the climate will be even stronger in the coming years. “Texas is a desirable market that does not have the barrier to entry that some of the other markets do,” Harsch says. “I continue to see retail being particularly active and lenders feeling comfortable lending here.”

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