a quick guide to credit considerations in real estate lending

Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending

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A QUICK GUIDE TO CREDIT CONSIDERATIONS INREAL ESTATE LENDINGCredit risk considerations for the three most-researched real estate industries on RMA’s eStatement Studies


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REAL ESTATE

• Lessors of Nonresidential Buildings (except Miniwarehouses)1

• Commercial and Institutional Building Construction2

• Lessors of Residential Buildings and Dwellings3


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COMMERCIAL LESSORS

1. LESSORS OF

NONRESIDENTIAL BUILDINGS (EXCEPT MINI-WAREHOUSES)


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CREDIT CONSIDERATIONS FOR COMMERCIAL LESSORS: ADVANTAGES

1As the business sector improves, so does demand for office, industrial, retail, and hospitality space.

The commercial leasing industry is expanding, boosting occupancy, and providing opportunities to increase rents.

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CREDIT CONSIDERATIONS FOR COMMERCIAL LESSORS: ADVANTAGES (CONT.)

3As operating revenue increases for commercial lessors, so should property value.

Volume and pricing for high-quality properties in the coastal markets have increased, a similar increase is expected in some secondary markets.

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CREDIT CONSIDERATIONS FOR COMMERCIAL LESSORS: RISKS

Demand varies by property type.

Demand for office space depends on office-related employment in the finance, insurance, technology, and real estate industries.

Demand for hospitality spaces is influenced by consumer spending, local business activity, the cost of travel, and the strength of the U.S. dollar.

Demand for retail space depends on consumer spending and increased employment in the finance, insurance, technology, and real estate industries.

Demand for industrial space is influenced by proximity to a labor pool, transportation, local tax rates, and the presence of related industries.


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CREDIT CONSIDERATIONS FOR COMMERCIAL LESSORS: RISKS (CONT.)

Equally important in determining

how this sector will fare is

Understanding how the national economy affects

local conditions—

which can vary widely by

State

Town


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CREDIT CONSIDERATIONS FOR COMMERCIAL LESSORS: RISKS (CONT.)

Demographics Tax burden

ZoningUtility

infrastructure

Demand in metropolitan markets can also be

influenced by:


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COMMERCIAL LESSORS:FUNDING NEEDS

Typically need funds for:

Land acquisition.

Land preparation and construction.

Property acquisition.

Working capital for ongoing financing needs.


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CREDIT RISK ISSUES TO CONSIDER FOR COMMERCIAL LESSORS

To make the smartest lending

decisions, rely on

eStatement Studies.

• Key candidate success factors that indicate a good credit risk.

• The critical external factors likely to affect the industry.

• Trends to watch that may have adverse effects on the industry.


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2. COMMERCIAL AND

INSTITUTIONAL BUILDING CONSTRUCTION


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CREDIT CONSIDERATIONS FOR COMMERCIAL AND INSTITUTIONAL BUILDERS: ADVANTAGES

As the nation’s economy rebounds, demand for new commercial and institutional building construction is growing at a steady pace.

Office building construction has been on an upswing over the last few years.

Institutional construction is expected to bounce back significantly after several years of a flat market, especially in the K-12 educational and public works sectors.

The rising trend of consumer spending and subsequent demand for new retail and office space is expected to grow industry revenue.

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CREDIT CONSIDERATIONS FOR COMMERCIAL AND INSTITUTIONAL BUILDERS: RISKS

Commercial and institutional builders rely on steel (a commodity prone to fluctuation) to construct a wide variety of structures.

Builders who try to generate business by keeping customer prices low could see negative effects on their profits.

External and internal factors determine how builders fare. Offsetting rising building material costs, tracking trends in office vacancy rates and consumer spending, and taking advantage of opportunities in private nonresidential construction will be key.

Delays caused by labor disputes or supply chain problems can also affect profitability.

Commercial and institutional builders must maintain access to skilled workers and subcontractors, secure new contracts without compromising price margins, and explore the pros and cons of upgrading to higher-quality construction materials.


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COMMERCIAL AND INSTITUTIONAL BUILDERS: FUNDING NEEDS

Typically need funds for: Land acquisition and development.Repositioning of underperforming properties.Equipment financing.Tract development.Construction labor and materials.Working capital for operating expenses.


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CREDIT RISK ISSUES TO CONSIDER FOR COMMERCIAL AND INSTITUTIONAL BUILDERS


decisions, rely on

eStatement Studies.

• How consumer spending affects demand for commercial and institutional building construction.

• Insight into key external drivers that influence profitability in this sector.

• The sectors that serve as major sources of demand and investments in this industry.

• How interest rates affect operating expenses and

profitability.

• How local government spending can be an indicator of profitability in this sector.


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3.LESSORS OF RESIDENTIAL BUILDINGS AND DWELLINGS


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CREDIT CONSIDERATIONS FOR RESIDENTIAL LESSORS: ADVANTAGES

1Rising employment and income growth are enhancing the residential rental sector.

3Renting is an attractive option for professionals who are now part of a highly mobile workforce that wants to remain flexible and move quickly without the constraints of homeownership.

Millennials are ripe for starting their own households but, because of low savings and high education debt, most lean toward renting rather than home buying.

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CREDIT CONSIDERATIONS FOR RESIDENTIAL LESSORS: ADVANTAGES (CONT.)

4Residential rental demand is expected to result in a rapid leasing pace which will push up occupancy and rent growth.

6Renting is an attractive option for professionals who are now part of a highly mobile workforce that wants to remain flexible and move quickly without the constraints of homeownership.

Many Baby Boomers are testing for retirement by renting, particularly in coastal areas.

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CREDIT CONSIDERATIONS FOR RESIDENTIAL LESSORS: RISKS

Demand varies by geographic sector, with just

a handful of areas driving

high national absorption rates.

Areas of greatest demand for residential rentals: Sun Belt,

West Coast, and Washington, D.C. metropolitan areas, Chicago and Boston. If employment in these

areas slows, so will the demand for

residential rentals.

A construction surge of multifamily housing in areas that are currently

in demand can pose localized risk in this segment, driving down

profitability.

If housing prices fall sharply and/or earnings growth improves, this

could weigh heavily on the growth of the rental sector as

homeownership becomes more affordable.


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RESIDENTIAL LESSORS:FUNDING NEEDS

Typically need funds for: Property renovations and repairs.Property acquisition.Land acquisition.Land preparation and construction.Working capital.


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CREDIT RISK ISSUES TO CONSIDER FOR RESIDENTIAL LESSORS


decisions, rely on

eStatement Studies.

• Which markets have the best potential to outperform?

• Observations into consumer habits that are affecting demand.

• Important questions to ask candidates that will help you determine risk.

• Trends to monitor that would indicate a change in the sector.


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ABOUT eSTATEMENT STUDIESSM

eStatement Studies is the online source for anyone involved in analyzing financial statements. It features two data set types:• Financial Ratio Benchmarks. • Industry Default Probabilities and Cash Flow.eStatement Studies gives you the power to make more informed financial decisions.

For more information, contact [email protected]

http://www.rmahq.org/estatement-studies/

mailto:[email protected]


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a quick guide to credit considerations in real estate lending

Economy & Finance