Turning the Corner

by Tony Petosa and Nick Bertino

Everybody seems to be feeling it: there has been a change in the commercial real estate lending market, including lending for Manufactured Home Communities (MHCs). Have we finally reached the light at the end of the tunnel? With many lenders projecting an increase in lending volume and hiring additional staff, we appear to have at least started to turn the corner.

Third party financing for MHCs has traditionally been obtained from the following sources:

Fannie Mae
CMBS Lenders
Banks
Life Companies

Let's take a look back and a look ahead at the lending climate for each of these sources:

Fannie Mae (FNMA). FNMA was a major lending source for MHCs in 2010. They offer long term, fixed-rate nonrecourse loans, and over the past two years have provided the most attractive overall terms available for MHCs. These loans are originated though a network of DUS (Delegated Underwriting & Servicing) lenders who are designated to underwrite, close, and service MHC loans for FNMA. Eligible properties are 3 to 5 star communities with stabilized occupancy.

In 2010, all MHC loans were designated as pre-review that is, FNMA had to review all MHC loan submittals before the DUS lender was permitted to formally quote an MHC loan. This was in reaction to a three-fold increase in MHC lending volume being originated by DUS lenders and a concern that credit standards may be slipping. Beginning in 2011, FNMA agreed to remove from pre-review status most age-restricted MHCs, and we anticipate that lower leverage all-age properties will follow. The pre-review designation and the required pre-approval before processing a loan can actually be viewed by the borrower as a positive step in the process, particularly for acquisitions. Although the borrower won't yet have a firm commitment, they may take comfort that FNMA has reviewed and conditionally approved the loan request prior to depositing money with the lender for third party reports and processing.

FNMA's 2010 MHC lending volume was down over 50% from 2009, which can be attributed in part to the pre-review requirement. An increase in interest rates during the 4th quarter also likely contributed to the decline as well as short-term extensions of existing loans. We expect FNMA to continue to adjust pricing and terms in 2011 to remain competitive, and that they will be a dependable lender in 2011 for many borrowers.

Commercial Mortgage Backed Securities (CMBS Lenders) - In 2008, the CMBS, or conduit industry was all but dismantled. However, in 2010 we experienced the early stages of a comeback in CMBS lending that has continued in 2011. Most of the prior major players have started to re-staff, yet few are now staffed at their prior levels. The largest conduit originator in 2010 was JP Morgan. They are now being joined by familiar names including Wells Fargo, Deutsche Bank, CIBC and Goldman Sachs to name a few.

Aside from more conservative underwriting standards relative to the pre-meltdown conduit days, the largest obstacle to increased loan production has been the need to recreate the origination infrastructure. Because most of these investment houses are staffed with just a fraction of the people they had two years ago, the focus in 2010 was on large loan transactions typically $10 million and above. However, as the staffing levels are increased and competition unfolds, we expect conduit lenders to be willing to entertain smaller loans in 2011. In fact, two lenders, Wells Fargo Bank and Guggenheim, have created loan origination programs geared specifically for smaller loans between $1 million and $5 million. This is welcomed news for many MHC owners. Underwriting is still conservative and is likely to remain so through the balance of 2011. Maximum loan amounts are typically 70% LTV, with a minimum debt yield (NOI divided by loan amount) of 9.0% - 10.0% for sizing of the loan, and up to 30 year amortizations.

A dozen or more conduit lenders have announced that they will be active in 2011, and we expect a significant increase in CMBS lending volume this year. However, total volume this year is still only expected to be about 25% of the annual volume levels achieved in the years leading up to the recent credit crunch.

Banks in 2009 and the first half of 2010, there had been a rush for the door by banks of all sizes struggling to shrink their loan portfolios. However, in the latter part of 2010, many banks reached the point that their real estate exposure was right-sized, so we expect many banks will gear up loan origination efforts in 2011. If they are able to write off enough bad loans on their books, they will be motivated and able to replace those loans. Bank loans are typically recourse, and borrowers can expect a more detailed review of all of their real estate assets, particularly any loans that mature within the next 12 months.

Insurance Companies unlike banks and conduit lenders, insurance companies have an ongoing need to invest cash. Millions of us continue to make payments on our property and life insurance policies, and that money needs to be invested so that sufficient funds will be available when the insurance proceeds are needed. Insurance companies have many places they can invest, but historically they have preferred long term fixed rate investments (like commercial real estate) with defined maturities. In 2010 some insurance companies were actively pursuing lending on high quality MHCs, and we expect insurance companies to be a major player in the commercial real estate sector in 2011. With respect to MHC lending specifically, we expect that they will continue to quote MHC loans, although they will be focused on higher quality assets and underwriting at more conservative leverage levels than what can often be achieved with other lenders.

In summary, the re-birth of CMBS lending should provide a significant increase in the money available for all commercial real estate loans, and especially for MHC loans. Conduit lenders have a strong appetite for MHCs because they have difficulty competing with Fannie Mae and Freddie Mac on apartment loans. MHC qualify as multi-family properties for conduit lenders, therefore providing much needed diversification in conduit loan pools. Having said this, there will be high demand due to normally scheduled maturities as well as the expiration of recent loan extensions so we suggest borrowers start the refinancing process early. Last year we predicted that commercial real estate lending would improve as 2010 progressed. We are pleased to say that overall this seems to be the case.

For more information, contact:

Tony Petosa

(760) 438-2153

tpetosa@wellsfargo.com

Nick Bertino (760) 438-2692 nick.bertino@wellsfargo.com

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This email contains comments relating to current market conditions in the real estate industry. Sources include various market participants deemed to be reliable. We do not guarantee such information, undertake to advise you of any changes, or make any representation as to its accuracy nor does such information represent the opinions of Wells Fargo Bank, N.A.

Turning the Corner

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