The days of readily available, low-cost capital that fueled a decade-long boom in Rochester’s commercial real estate market are now a memory, replaced by a more disciplined and demanding financial landscape. A confluence of persistent inflation in construction costs and a sustained higher interest rate environment has fundamentally altered the calculus for developers and investors. Leading regional lenders, from Jon Fogle at ESL Federal Credit Union to Patrick C. Keating at Five Star Bank, universally agree that the market has entered a new phase. This era is defined not by speculative growth but by a return to fundamentals, where significant cash contributions from borrowers are no longer a preference but a prerequisite for securing financing and bringing projects to fruition.
The New Financial Reality How Deals Get Done
The End of Easy Leverage
The defining trend across Rochester’s commercial real estate sector is a market-wide deleveraging, a significant pivot from the practices of just a few years ago. Lenders are increasingly shifting their focus from a property’s appraised value to its actual cash-generating capability. The primary question is no longer “What is the property worth?” but rather “Can its net operating income comfortably cover the higher debt service costs of today?” This emphasis on cash flow has created a more formidable environment, especially for new construction and certain asset classes struggling with post-pandemic realities. As a result, the critical importance of a borrower’s liquidity, combined with meticulous financial planning and a robust relationship with their lender, has been thrust into the spotlight as the key determinant of a project’s viability in this normalized market.
The Mechanics of the Equity Squeeze
The primary instrument forcing this increase in equity is the debt-service coverage ratio (DSCR), a non-negotiable metric for lenders assessing risk. Jon Fogle of ESL clarifies that his institution typically requires a DSCR of at least 1.2x, meaning a property’s net operating income must be 20% greater than its total debt service for the year. The challenge arises from the dramatic shift in interest rates, which have climbed from historical lows near 3% to a new baseline closer to 6%. This has effectively doubled the annual debt service on a given loan amount. To maintain that crucial 1.2x coverage ratio in such an environment, the total loan amount must be significantly reduced. This reduction creates a substantial financing gap, a void that the borrower is now required to fill with their own cash, thereby increasing their equity stake in the project from the outset. Fogle stresses that even if a project’s appraisal supports a high loan-to-value (LTV) ratio of 75-80%, the DSCR requirement now acts as the ultimate governor on leverage, dictating the final loan size and reshaping deal structures across the board.
For new construction ventures, this financial pressure is compounded by the loan-to-cost (LTC) requirement, which is applied against a backdrop of soaring development expenses. Persistent inflation in both building materials and labor has driven up the total cost to complete a project. Consequently, a loan that covers a traditional 75-80% of these now-inflated costs still leaves a much larger absolute dollar amount for the developer to fund out of pocket. This dynamic further escalates the upfront equity needed, placing immense strain on a developer’s capital reserves. Patrick C. Keating of Five Star Bank corroborates this market-wide shift, observing that across nearly all property sectors, equity requirements have climbed by at least 5% to 10% compared to just a few years ago. This new reality demands a level of financial fortification from developers that was less common in the previous low-rate cycle, effectively filtering out less-capitalized players and ensuring that only the most financially sound projects proceed.
A Market of Haves and Have Nots
Uneven Pressure Across Property Sectors
These stringent equity demands are not being applied uniformly, creating a clear divergence in performance among different commercial real estate sectors. The office property market is confronting the most significant challenges. Widespread adoption of remote and hybrid work models has created deep uncertainty about long-term demand, suppressing rental income growth and depressing valuations. This is particularly problematic for owners of buildings financed with low-interest loans that are now maturing. As these loans come due, property owners are discovering that their assets have not amortized sufficiently to qualify for refinancing at today’s higher rates without a substantial injection of fresh equity, a capital call that many are unprepared to meet. The hospitality sector faces a similar uphill battle. Lenders have long viewed it as a more volatile asset class, and in the current climate of risk aversion, that view has only hardened. Keating notes that LTV ratios for hotel projects are often capped closer to 65%, a stark contrast to more favored sectors, demanding a significantly larger down payment from investors.
In stark contrast to the struggling office and hospitality sectors, the multifamily and industrial segments have demonstrated remarkable resilience, solidifying their status as the darlings of the lending community. Unwavering demand for housing and logistics space continues to support robust rental growth and stable cash flows, which in turn justifies strong valuations. These fundamentals allow multifamily and industrial projects to command the most favorable financing terms available, with LTVs frequently reaching the 75% to 80% range, a level now unattainable for most other asset classes. However, even previously booming niche sectors are facing renewed scrutiny. Self-storage, once a high-growth area, is now showing signs of market saturation in certain submarkets. This has prompted lenders to become more cautious, leading to more conservative underwriting standards and, consequently, higher equity demands for new self-storage developments as the market seeks a new equilibrium.
The Borrower’s Burden Capital and Collaboration
In the current market, lenders are placing an unprecedented emphasis on “sponsorship”—a term encompassing the borrower’s or developer’s financial strength, industry experience, and overall reputation. A strong personal balance sheet and significant liquidity are no longer just advantageous; they have become non-negotiable criteria. Lenders are meticulously scrutinizing the ability of sponsors to absorb unexpected cost overruns and contribute additional cash if a project runs into trouble. This heightened diligence has a direct impact on the market, as Fogle notes that developers who lack sufficient liquid reserves or are hesitant to increase their equity positions are increasingly choosing to pause or shelve projects. They are opting to wait on the sidelines in hopes of a more favorable interest rate or construction cost environment, leading to a general slowdown in the pipeline of new developments.
Beyond deep pockets, the success of a commercial real estate deal in Rochester now heavily relies on the strength and transparency of the relationship between the borrower and their lender. The days of transactional, arms-length banking are over. Both Fogle and Keating emphasize that strong, proactive partnerships are more critical than ever. Early and continuous communication regarding a project’s progress, potential challenges, and any deviation from initial projections is paramount. This open dialogue allows banks to be more flexible and creative in structuring solutions, whether it involves adjusting timelines, reallocating funds, or exploring alternative financing options. This collaborative approach can be the decisive factor that keeps a project on track through turbulent periods, distinguishing successful ventures from those that falter under the weight of unforeseen obstacles. A trusted banking partnership has become as valuable an asset as the property itself.
A Return to Fundamentals
The cumulative effect of these higher equity requirements was a discernible muting of deal flow throughout the Rochester region. With more cash needed for every transaction, investment returns were naturally compressed. This shift prompted some investors to reconsider their allocation to commercial real estate, especially when equity markets offered strong returns with what was perceived as less operational risk. However, this environment was not viewed as a crisis by market experts. Instead, it was framed as a necessary return to a more normalized and historically typical financial landscape. The consensus was that good deals remained viable, but they demanded a higher degree of sophistication, including more realistic projections and sharper pencils from borrowers. The guidance for navigating this market became a mantrmaintain strong liquidity, engage with lenders early and often, and be prepared to bring more of one’s own capital to the table. Ultimately, the market had recalibrated to reward well-prepared, well-capitalized operators who possessed strong local knowledge and had cultivated established banking partnerships.
