As the climate of risk aversion among banks persists, there is a growing trend for smaller equity financed deals, while borrowers face much stricter lending criteria, says Lynn Strongin Dodds

While the US Federal Reserve and the Bank of England's recent round of liquidity injections were welcomed, lending conditions will remain tight for the rest of the year. Banks are unlikely to give an inch, keeping a tight rein on their purse strings and an even more circumspect view of property transactions.
According to industry participants the only banks digging into their pockets today are the large balance-sheet lenders. Investment banks are out of the picture as they are busy trying to restore their badly battered operations back to health. Although there may be glimmers of hope, it will take a long time before these players are actively back in the market.
One reason is that mortgage-backed security markets, which helped fuel the property booms on both sides of the Atlantic, have virtually disappeared. In the US, commercial mortgage backed securities (CMBS) had accounted for nearly a quarter of the $3,220bn  (€2063bn) in outstanding mortgages for commercial properties. So far, this year has seen the smallest amount of commercial mortgages sold on as securities since 1991. January was the first month since the inception of the market in 1990 in which no CMBS was issued, and February only saw the slightest pick-up. Jones Lang LaSalle, a global property management group, expects $30bn-$50bn in issuance this year, down from $220bn last year.
While the general consensus is that the CMBS market will eventually revive, borrowers for now will have to make do with old-fashioned bank lending. The challenge this time around, though, is that the criteria are tighter, with higher interest rates and tougher terms being extracted on the loans. In the UK, the largest property market in Europe, banks are now pricing real estate loans up to 170bps, while loan to value (LTVs) now stand at around 70% from 75% at the end of last year, and a lofty 90% to 100% before the credit crunch hit.
As for due diligence, the documentation may be slightly more rigorous but it is certainly taking longer to close a deal. Nick Burnell, a managing partner of Rutley Capital Partners, the real estate private equity business of Knight Frank, says: "Banks are focusing more on the underlying assets and their performance, particularly interest coverage and rental growth. They want to ensure that every ‘t' is crossed and every ‘i' dotted in the due diligence process, and that property valuations are underpinned by strong fundamentals offering protection against immediate downward revaluation."
In addition, as Alessandro Bronda, head of property investment strategy at Aberdeen Property Investors, notes, there is less money around for the €1bn plus-type of deals that were so prevalent pre-credit crunch. "There is no doubt that the UK banks especially are much more risk averse and do not want to lend to large transactions. Instead, we are seeing a number of equity financed smaller deals. It is a similar story in the US and the rest of Europe, although the outlook is better in the Nordic markets and Germany on the back of predictions of modest growth."
Herbert Spangler, head of structured finance at Invesco in Munich, adds that German banks tended to be more conservative, with LTVs in the 60% range and margins between 80-95bps. They also have the advantage of tapping the jumbo Pfandbrief market, which provides a deep and efficient pool of liquidity for real estate. As for the French and Dutch banks, "they are in the middle between Germany and UK in terms of pricing. They were not as badly affected as the UK banks and have the balance sheets to lend but do not have the ability to refinance as easily as the Landesbanks."

In general, though, few banks are willing to go it alone and shoulder a whole deal, even at the smaller end of the spectrum. Barry Osilaja, director, corporate finance at Jones Lang LaSalle, says: "In the UK, banks only want to underwrite £30m to £40m, which means that at the upper end there are more club deals. The other trend we are seeing is that they prefer to lend to an existing relationship where they can generate additional business. They are becoming more selective in terms of the new clients they will do business with."
Not surprisingly, against the current credit crunch backdrop, there is not much lending activity. Volumes are down with investors waiting for a price floor to be reached. A report from global consultancy Cushman & Wakefield revealed that the total value of commercial property deals in the once red hot central London market hit a three-year low in the first quarter of 2008. About £2.8bn of transactions took place in the first three months of 2008, compared with £3.9bn in the corresponding quarter of 2007. The City of London only saw a total of about £1.25bn, which was around half for the same period in 2007.
In London's West End, investment volumes of £1.6bn were close to levels seen in the comparable period last year, but the bulk were sales made by institutions offloading assets to satisfy investor requests to exit open-ended property funds. The Cushman & Wakefield report noted that the forced selling has mainly stopped, although this could lead into a contraction of sales in the second quarter.
Industry experts predict that global investment market volume will be down about 30% this year from the lofty heights of 2007. Not even Asia, though more resilient, is expected to achieve the same levels as last year.
Looking ahead, some are hoping that the distressed sector will yield some fruitful opportunities, although the European market has not yet hit the bargain basement prices.
By contrast, the vultures are already circling the US, which has been harder hit by the sub-prime crisis, with prices in many areas thought to have hit rock bottom. At least $30bn has been, or is being, raised to invest in distressed property since last August, according to Costar Group, which tracks commercial real estate transactions.