PERSON OF THE WEEK: Mark Zytko On Surviving The Commercial Mortgage Market’s Melancholy 2009

Written by Jessica Lillian
on January 13, 2009 No Comments
Categories : Person Of The Week

All signs seem to point to a challenging year for participants in commercial real estate loans, but dealmakers who recognize the realities of the climate and focus on quality properties will be well positioned to enjoy that light at the end of the tunnel.

When might we see that light? What should we do in the meantime?

For perspective on both the origination and servicing sides of the commercial mortgage world, MortgageOrb discussed trends and tips with Mark Zytko, principal of Los Angeles-headquartered real estate finance company Mesa West Capital.

Q: In the loan servicing portion of your business, have you been seeing a meaningful rise in defaults/delinquencies and other loan complications yet? Have you pursued any specific strategies or ramped up staff in anticipation of a rise in delinquency issues?

Mark Zytko: We have always serviced the loans we originate. This has allowed us to be more proactive and responsive in managing portfolio risk, as well as strengthen relationships with our borrowers. While this was important in a healthy market, it is even more critical in these difficult times.

In any market cycle, there are two types of deals – those that perform well at the underlying property level and those that do not. It is those inefficiencies that drive our industry.

Historically, most projects perform well, especially in the past few years and in places where occupancy was high and rents were strong. But in any market, you're still going to have some deals that don't perform, and that's always of concern. However, the past few years were characterized by hyperliquidity and a strong investment sales market. So, regardless of the underlying property's performance, loans were going to get paid off.

The market was getting away from real estate fundamentals and becoming one of financial engineering. What is most troublesome is that both lenders and borrowers understood that, and despite that knowledge, they continued to push values further and further up and risk premiums further and further down.

That dynamic has changed. Needless to say, the overlay for the problems we're experiencing is a weakening economy. Capital has all but dried up, and the investment sales market is dead in the water.

As a result, we are definitely seeing that both the weaker loans and the strong loans are having trouble being repaid. Are the increases meaningful? Compared to the past several years, yes. But they are manageable, and because we've always serviced our loans, we have been able to deal with these issues. That said, the majority of our deals are performing well.

Q: As a bridge lender – which means you may lend on risky or underperforming properties – how do you recognize projects that are likely to reach stabilization and succeed, especially now that the market as a whole has become so cautious?

Zytko: We've never really been a company that has loaned money on risky or underperforming properties. Our focus is to provide short-term first mortgages to strong sponsors on good-quality properties. In today's market, we are active with borrowers who want to bridge the capital markets' dislocation and don't want to commit themselves to long-term financing on unattractive terms.

Critical to any lending decision is understanding who the borrower is, whether the borrower is doing the right things and whether the property is well positioned. Simply said – solid underwriting.

It is also important to choose markets, properties and borrowers that you understand well. Experienced and well-capitalized borrowers have always been important to us, and this is even more critical as we work through this cycle.

The non-core, esoteric property types have always been red flags. Those who were hungry to do deals and ignored the red flags are the ones that are in trouble today.

Q: Many in the CREF industry have criticized government intervention efforts so far for their lack of effect on our industry. Other than the potential TALF access, is there something else the government should be doing now to help CRE specifically?

Zytko:
The government's first priority was to try to help institutions rather than help individuals directly. Unfortunately, the first dose of money is not helping institutions make new loans; rather, for most, it is preventing them from failing.

It is important to understand that these institutions must be stabilized before they can make new loans, and it won't happen overnight. It may take more stimulus and more time.

People need to understand that you can't give them money and expect them to get off their death beds right away. The problems we're experiencing in the capital markets didn't happen overnight, and the solutions won't come that quickly either.

The government seems willing to infuse as much capital as possible. While the focus primarily has been through direct investment in financial institutions, another step would be for the government to provide additional support to securitization markets in various products through guarantees and/or additional liquidity as a buyer.

With the exception of Fannie Mae and Freddie Mac, that hasn't happened yet. Without a stimulus to help with both liquidity and confidence, the securitization markets will be slow to return.

Q: What's your overall outlook on commercial real estate lending for 2009? What trends should we look for? Is there any good news?

Zytko: Lending should remain extremely muted in the beginning of the year, and I don't see it stabilizing for at least a year – or maybe longer. Contributing to the malaise is that values are not done falling, simply because there is an unwillingness to transact. Many people simply don't have the money to transact, and for those that do, values simply are not attractive enough – nor are returns high enough – to get them to take the first step.

Remember, hyperliquidity contributed to the driving up of real estate values. I believe prices need to drop 30% to 40% or more from their peaks. That may mean another 10% or 20% drop, depending upon the market or property type.

Values in core property types – especially in infill locations – will fall less. Weaker real estate will fall a lot more, but overall, the declines should fall in the same general range.

These declines sound dramatic, but they are really rational and healthy. They represent a deleveraging of commercial real estate (parallel to what is occurring with all financial products) and a return to attractive return levels and substantial risk premiums. When we have achieved those things, investments will begin to increase and markets will recover.

Many are concerned with the pending wave of CMBS loans that will begin to mature in 2009. The good news is that 2009 will be a trickle compared to the bulk of loans maturing in 2010 and beyond.

I believe those loans coming due in 2009 will actually be good for the market, as this will help to define capitulation and force people to get into the market and transact. This process will take place over the course of the year. Then – and only then – we will see the bottom.

There is no magic dust we can sprinkle over this situation and hope that it goes away. As an industry, our goal in 2009 is to the find the stabilization level, and then hope that 2010 will be the year we begin to move forward. In real estate, both up cycles and down cycles occur over a period of years, and we will eventually get through this.

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