Commercial and multi-family real estate investors are finding it more and more difficult to obtain adequate financing at reasonable rates. As a result, a variety of data sources indicate a reduction of 65-80%  in 2008 vs. 2007 total transactions.

One of the most significant causes of the credit crunch has been  the near disappearance of new Collateralized Mortgage-Backed Securities (CMBS) securitized by commercial and multi-family mortgages. Until now CMBSs have provided a robust and much needed secondary market for loans on commercial and multi-family properties. But the volume of these bonds has declined from approximately $61.2B  in 1Q07 to less than $5.6B in 1Q08  (-90%). Conduit lenders in their peak quarter in 2Q07 issued approximately $75B. Insurance companies, local banks and thrifts have taken up only a small portion of the slack.

In addition to their problems with subprime and Alt-A loans, regional and investment banks are still working to rebuild required reserves. Although voices can be heard proclaiming that the end of the crisis is near at hand, the number of foreclosures in those markets  most affected by the subprime problem (CA, NV, AZ, NM and Fl) have tripled in the first 7 months of 2008 compared to the same period in 2007. So it is evident that a bottom is nowhere in sight. To top it off, the Financial Accounting Board of Standards at the urging of the Mortgage Banker’s Association has postponed the implementation of FAS 140 which would have required banks to bring onto their balance statements the total of debt held in off-balance sheet, Enron-like Qualified Special Investment Vehicles (QSIV). The postponement gives the investment banks another year of obfuscation to repair their damage.

We are also now beginning to learn of the size of the debt facing the institutions that were active in the Auction Rate Securities (ARS) market. ARS are bonds issued with a coupon rate that resets every 7, 14 or 35 days. ARSs have been  touted by the sellers as equivalent to cash but earning more than savings accounts. Most securities were rated AAA and were federal, state and local tax-exempt. They had special appeal to municipalities, pension funds and to those high net-worth individuals who could afford the $25,000 minimum investment.

When a holder of an ARS wanted to sell but could not find a buyer, the issuer stepped up to either acquire the security or guarantee a minimum interest rate for the next period. But all this stopped on Feb.13, 2008 when the investment banks, who have issued more than half the $330B in outstanding ARSs, withdrew their support. More than 80% of the auctions failed. Some banks (e.g. UBS) announced they were marking down the value of the ARS in  clients’ accounts from a few percentage points to more than 20%. As the result of the threat of legal action by the SEC and the N.Y. State Attorney General Cuomo, who charged that the issuers committed fraud by representing the securities as equivalent to cash, a number of major investment banks have announced that they will buy back ARS from private investors. UBS is committed to redeem $19B while Merril l Lynch and Citi have pledged to buy $17B from individuals. Institutional investors and student-loan organizations may not fare quite so well. This additional pressure on lenders further restricts available loan funds.

Those lenders still in the market have increased their interest rates and tightened up considerably on their underwriting standards. Rates for loans scheduled over 30 years but due in 10  years are now 250 – 275 basis points over the comparable Treasury yield (the 10-year Treasury is now ~ 4.0%). Loan amounts are restricted to 65% of appraised value or to an amount supported by a Debt Coverage Ratio of at least 1.25, whichever is lower .

Sellers have also made financing difficult by clinging to yesterday’s high prices. California multi-family properties in the $1-5M range are still offered at cap rates of 4.5-5.3%. At these low cap rates, properties do not deliver adequate Net Operating Income to offer a chance of reasonable (65%) leverage.  The higher down payment required places the hope of an adequate yield (IRR) over 5-10 years on the attainment of much higher rents. But despite higher foreclosure rates on single-family homes, vacancy rates in many markets are rising, not falling.

The investor’s life at this time is not a bowl of cherries.