AS THE GOVERNMENT-SPONSORED enterprises (GSEs) continue to dominate the multifamily lending arena, many institutional lenders are shying away from new originations.

The problem for many portfolio lenders is a lack of turnover. In the past, lenders could expect a chunk of their loans to come off of their balance sheets through prepayment or maturity, freeing up more capital for new loans. That's not the case this year.

“We have less appetite for new loans in 2009, but what really drives that is the fact that discretionary prepayments have slowed down because transaction activity slowed down,” says David Durning, senior managing director of Newark, N.J.-based Prudential Mortgage Capital Co.

In some cases, life insurance companies such as Northwestern Mutual are offering discounts to existing borrowers to prepay their loans and help clear their books of commercial real estate.

Not every insurance company, pension fund, and bank is shrinking its commercial real estate book. But even those still actively lending are allocating more capital to re-upping maturing debt, so there's very little new money coming out. And that bodes poorly for property owners looking for alternates to the GSEs.

Ebbs and Flows

Durning has noticed a change in borrower psychology since the end of the second quarter. For many in the industry, there's a sense that the bottom has been reached, and borrowers are less panicked about managing maturities over the next three years. That renewed optimism means fewer owners are looking to refinance.

“They're thinking there's going to be better, more attractive debt available in 2011 and 2012, so they're staying with whatever financing they have right now and not locking into something long term that may not look attractive in the near term,” Durning says.

Prudential, for one, is looking to lend between $3.5 billion and $4 billion to commercial real estate from its general account this year. About $1.5 billion of that has been earmarked for maturities within its portfolio. The balance would be for new originations, an opportunity that grows more reduced as the year goes on.

“Since the CMBS market ceased, it had been a very good time for life insurance lenders,” Durning said in mid-August. “But over the last 12 weeks, it has slowed down quite a bit.”

Another problem for portfolio lenders is the cost of funds. Rates from institutional lenders are routinely between 7 percent and 8 percent, while borrowers can still get rates in the mid-5 percent to 6 percent range from the GSEs. And the leverage levels that institutional lenders can offer get squeezed a little bit more each month.

“The leverage requirements are now down in the 60 percent range, and their rates are in the 7-plus percent range,” says Phil Melton, a senior vice president of Charlotte, N.C.-based Grandbridge Real Estate Capital, which serves as a correspondent to dozens of life insurance companies. “That's 10 basis points lower loan-to-value and 100 basis points higher than the [government] agencies, and there aren't a whole lot of players who want to play in that space.”

Many institutional lenders are instead targeting retail, office, and industrial properties—sectors with less liquidity than the multifamily industry. But for borrowers looking to fund transitional properties (an area the GSEs won't touch anymore), institutional lenders are a good bet.

“They can win deals, such as financing on properties still in lease-up, that are not a fit for the agencies,” says Terry Halverson, a vice president at Horsham, Pa.-based Capmark Finance, which acts as a correspondent for life insurance companies.

Hard Money for Hard Times

As institutional lenders and the GSEs both grow more selective, some borrowers are turning to hard-money lenders to help steer them through the downturn. These short-term lenders, such as Kennedy Funding and Mercury Capital, feature quick closings, usually in less than two weeks, and the loan terms are often flexible.

But the money is costly: Rates often start in the mid- to high-teens for the loan's first year and get higher each year thereafter. “Sometimes it's the only alternative,” Melton says. “If they've got maturity defaults, and the lender is going to foreclose, they may not have a choice.”

During the conduit lender boom, few borrowers had any need for such an execution since cheap money was plentiful. But beginning in early 2008, these lenders have seen a spike in business. Borrowers need to beware, especially since small, less reputable hard-money lenders are popping up to take advantage of distressed situations.

Some hard-money lenders promise the world, and a borrower puts down a nonrefundable deposit—say $15,000—only to learn the deal was not accepted. To avoid that scenario, borrowers should make sure the commitment fee is reasonable— not more than 1 percent of the proposed loan amount. And that fee should be fully refundable, minus reasonable expenses.

“There are people preying on folks who are desperate, saying we can get your deal done, put up an expense deposit,” Melton explains. “And then they say, sorry, but all the money is gone.”