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CREFW-Fall2014 10.15.14

A publication of Autumn issue 2014 sponsored by CRE Finance World Autumn 2014 17 very real estate specific and sponsor-specific approach and we really try to dig into each individual underwriting. Often an issuer’s approach and metrics differ from the rating agencies particularly in terms of cap rates, where rating agency cap rates are set at levels that even in the downturn weren’t consistent for a long period of time. They tend to be extremely high and therefore generate valuations that result in high LTVs that are not consistent with where properties are trading in the market. Kim Diamond: I completely agree with everything you’re saying. There’s no question about it. It is very, very case specific. I would say that for every example of what you’re citing, while those do exist, there is a preponderance of examples where that discipline is not being applied. David Brickman: If I could jump in on this question of our position in the underwriting cycle, I might be a little in the middle of these two views. I would agree with much of what Peter said in terms of the environment. We also can point to observable, factually precise loan attributes that while looser are not unreasonable in the current environment. I am thinking of things like the amount of IO or leverage levels. We can assess those based on the economic environment and point to rational reasons why they are supported by the current real estate environment. I think what concerns me though, going the other direction, are the more qualitative factors; the ones that don’t get picked up as readily in any model or analysis. I think both Peter and Kim are touching on them, the quality of the income being underwritten. I think when we look at what went wrong pre-crisis, certainly that’s what we circle, poor quality or pro-forma underwriting. I think there is in our mind looking at multi-family and deals done away from us, there is clearly a degree of wishful thinking in some of the underwriting that is going on. It’s not misrepresentation, it’s not fraud, if you will, but there is clearly some degree of excess optimism in underwriting that is occurring which is the first step down that path that we think is more problematic. Certainly people choose to put more or less leverage on, I think that’s more of an economic choice, but we do want to be careful about maintaining the same standards about how we assess income. Other attributes relate to loan structure, if you will, guarantors, Kim touched on reserves, and funded reserves and escrows, other loan attributes more related to the qualitative aspects of the loan we see as slipping in a more material fashion. Then lastly, in terms of quality, I don’t know if the quality of sponsors or quality of real estate is any different today than before so much as we notice that there seems to be a lesser reliance on the quality of the sponsor and real estate in making some of these very same qualitative decisions that’s there was in the last couple of years. Sam Chandan: Brian, How do you see our move to non-core property types, secondary markets, and less emphasis on sponsorship? Do you see risk taking along any of those dimensions? Brian Olasov: Absolutely. I actually consider that to be a somewhat healthy development. I describe that as the democratization of credit. Large institutional, low leverage lenders and strong sponsors moved into the gateway cities and trophy properties. That was an inevitable consequence of the shock that we all suffered through the Great Recession. So you expect that investors are going to move from liquid to less liquid markets. And with that compromise, the give-up in moving to secondary and tertiary cities is decreased liquidity. And if the pricing is rational, as you lose liquidity, you pick up yield and we’ve definitely seen that. What we haven’t seen during this rebound, is a strong snapback of new construction. The little bit of construction lending going on has really been focused on multifamily and there are some pretty unique demographic reasons that may justify the movement into construction and development for multifamily. Sam Chandan: Do these shifts have parallels on the equity side of the business? Are there still segments of the markets that are still starved for capital or have we put that behind us now? Or is it rather the opposite, that we have segments of the markets that are saturated? Peter Scola: I don’t think the word ‘starved’ necessarily applies anymore. I think you have a lot of different equity sources. I often hear about equity investors wanting to deploy capital in only gateway markets. They all want New York, San Francisco, Los Angeles, and Washington, DC. This has created a situation where these primary markets seem saturated and buyers aren’t able to achieve their now unrealistic return expectations. If it is in the U.S., frankly I think if it’s in other major cities around the world, there’s a big pull towards real estate. CRE Finance Roundtable: The Risk Cycle


CREFW-Fall2014 10.15.14
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