Mariwyn Evans writes about commercial real estate for REALTOR® Magazine. You can reach her at firstname.lastname@example.org.
Find Me the Money
The credit spigot is starting to trickle, but it's a long way to a steady flow.
August 1, 2010
Lending is looking up. New commercial loans jumped 12 percent in the first quarter of the year compared with the same period a year earlier, continuing the upward trend from late 2009, according to the Mortgage Bankers Association.
"I’m actually getting phone calls from mortgage brokers," says Todd Clarke, CCIM, president of NM Apartment Advisors Inc. in Albuquerque, N.M., though he adds that so far it’s been more talk than deal-making.
That too may change. A survey of 60 lenders conducted by Jones Lang LaSalle early this year found that 43 percent expect their loan production to more than double this year from their 2009 volume. But "better" still doesn’t mean "good." If you want to get financing done today, you need the right property, the right market, the best tenants, and an experienced borrower or sponsor.
"You have to hit the golf ball into the center of the fairway to stay in the game," says Constantine Korologos, managing director in the real estate practice at Deloitte Financial Advisory Services in New York. Good properties may actually get multiple loan offers. Competition for them is actually lowering costs.
"A year ago, a life insurer would offer 55 percent leverage with a 7 1/4 percent interest rate. Today, you might be able to borrow at 60 percent loan to value, with a 6 percent rate," Korologos says.
But the picture’s not so rosy if your property isn’t among the elite. Buildings with high vacancies, short leases, or construction issues generally have to contend with higher cost loans from hard money lenders—if they can get funds at all. "It’s a binary market," says Michael Mounts, who heads Jones Lang LaSalle’s investment banking practice.
Banks Take What They Can Tolerate
So, where is the money coming from today? "Commercial banks are still a big question this year," says Bill Hughes, senior vice president of Marcus and Millichap Capital Corp. in San Francisco.
Loan availability in this sector, which already holds approximately 45 percent of commercial real estate loans, according to Deloitte Development, will largely depend on how many troubled loans a bank currently holds and how much pressure it is under from regulators to boost reserves, says Steve Roth, executive vice president in the Chicago office of Grubb & Ellis.
"Most of the loan activity I’m seeing is coming from community banks that stuck to their core lending practices and aren’t saddled with larger numbers of troubled assets or that are new," says Thomas "Gus" Grizzard, CCIM, president of ERA Tom Grizzard, REALTORS®, in Leesburg, Fla. In general, Grizzard is seeing 75 percent LTV with a 20 year amortization and a three-year balloon.
Banks are also spending more time scrutinizing financials than every before, says Mark Shapiro, director of brokerage business at KW Commercial in Baltimore.
"A few years ago, market studies were just a formality. Now lenders are often basing valuations on current versus projected income," he says.
In some cases, local banks will lend just to keep from foreclosing, reports Larry Hausman, CCIM, senior associate with Marcus & Millichap in Louisville, Ky.
"I just did a deal in which the seller of a 50 percent–vacant strip center paid down the loan by 25 percent and negotiated with the bank to provide 100 percent on the outstanding balance with a 20-year amortization to the buyer," he says.
The bank knew that the seller, an investor with limited real estate experience, wouldn’t requalify. It also helped that the buyer was an experienced owner with similar properties and good credit.
"Banks are changing the way they do business and bending over backwards not to take properties," Hausman says.
Hard Money Stays in the Game
Third-party structured lenders, often referred to as hard money lenders, remain an active source of lending, but "it’s still very difficult to get financing done for properties that aren’t leased or that have weak tenants," says Jody Thornton, executive managing director in the Dallas office of Holliday Fenoglio Fowler, a major financial intermediary for commercial real estate.
As is the case with banks and life insurance companies, "lending is back to a blue-collar business, where we are studying every lease, analyzing NOI (net operating income), and going over every detail of the borrower’s business plan," Thornton says.
Lenders are also looking more closely at a borrower’s overall financial picture, instead of concentrating just on the asset being financed, Hughes says. Lenders are underwriting "a borrower’s global cash flow" since a weak asset could be draining funds from a good one, he explains.
Filling the Equity Gap
Mezzanine or bridge debt, which is used to bridge the gap between a primary mortgage’s loan to value and buyer equity, is also getting a little more affordable. Mezz debt lenders are willing to accept lower, more realistic yields in the 10 percent to 12 percent range, which has improved liquidity for borrowers who need extra funds, says Thornton.
In general, lenders are apt to finance a combined 75 percent or 85 percent LTV for a first and mezzanine commercial property loans, says Aaron Birnbaum, executive vice president at Meridian Capital Group LLC in New York.
Bridge loans are also a boon for properties that need funds for retenanting or construction completion. Michael Miyagishima, CCIM, managing director with Sperry Van Ness MCRE Inc. in San Francisco, reports that a client plans to use a 36-month bridge loan to purchase a broken condominium deal and complete the conversion to a rental property. Once the property is rented, the new owner will look for permanent financing.
An alternative funding source when a senior lender won’t permit bridge financing is to sell a preferred equity position in the property. Meridian Capital Group used that technique to fill a $13 million funding gap for the owner of a Wal-Mart–anchored retail center in Charlotte, N.C.
Although the difficult deal took some time to negotiate with the lender, it closed at 300 basis points below the initially proposed interest rate, another sign of a better lending climate, says Birnbaum.
U.S. Program Helps Capital Flow
Government-supported entities such as HUD, Fannie Mae, and Freddie Mac are also a prime source of lending, particularly for multifamily.
"Fannie Mae’s Delegated Underwriting and Servicing program, which offers both first and bridge loans, is definitely underwriting better quality properties because more borrowers are using the program," Hughes says. As a result, "that’s giving it the confidence to be a little more aggressive in its lending standards for good properties in strong markets."
"Fannie Mae’s interest rates are good, but the prepayment penalties are so stringent that I don’t encourage buyers to use the program if they have an alternative," says Bill Doumar, CCIM, with RE/MAX Commercial & Investment Realty in Los Angeles. If an owner wants to pay off the loan or sell the property before the loan term ends, the penalties negate any interest rate savings, he says.
Freddie Mac’s products have traditionally been better suited than Fannie Mae’s for deals that required more creativity and more upfront underwriting, says Jeff Hurley, who heads the CBRE Capital Markets Group, which originates loans sold to Freddie Mac.
A new program, which launched this spring, expands Freddie’s options. It includes both a traditional first mortgage as well as a mezzanine piece for a designated lender. The combination will bring total LTVs into the 85 percent range.
"The program is ideal for refinancing some of the CMBS loans that are beginning to come due," Hurley says.
Freddie Mac has good interest rates and debt coverage ratios, says Miyagishima, but the HUD 221 (d) (4) is his loan of choice for multifamily. The appeal: Higher LTV lets an investor pull money out after an asset is stabilized.
A client used this technique in the purchase, renovation, and repositioning of a 450-unit Nevada multifamily property. The 35-year term, nonrecourse, and no-fee assumability also make HUD loans attractive to investors with a longer hold horizon, he says. The challenge is finding larger multifamily properties built since 2000, a requirement for the program. And it can take six months to close.
Another existing HUD program attracting new interest is the New Market Tax Credit, which offers salable credits to help fund development in economically challenged areas. NMTCs work through partnerships between private developers and a Community Development Entity. The private developer owns the property and then leases it to the CDE on a master lease. Funds generated from the credits then flow through the CDE to the developer.
For business owners, the Small Business Administration loan program remains a great way to finance a purchase of a commercial property they use for business. The SBA 504 loan program lets a buyer borrow up to $2 million, but President Obama has proposed increasing the 504 loan limits to $5 million. SBA terms are attractive, with up to 90 percent financing provided by private lenders.
Even the requirement that SBA loan recipients must use more than 50 percent of a property for business purposes isn’t insurmountable.
"I’ve seen investors who purchased a small dry cleaning business in a strip center just to get control of the property," says Chris Sands, who heads the Sands Investment Group in Santa Monica, Calif.
Beyond the Usual Lenders
If conventional lending sources aren’t working, there are still some options.
"I recently saw a $2 million deal for the purchase of a property in Texas where the funding, at 75 percent LTV and a competitive interest rate, came from a credit union in Oregon," says Cynthia Shelton, CCIM, cre, a broker with Colliers Arnold in Orlando.
The catch: By regulation, credit unions can lend only 12.5 percent of their total assets, though a bill now in Congress would raise that cap to 25 percent. You also have to be a member of the credit union to secure a loan.
Another way to fill the gap between what you can borrow and what you need is joint venture funds. Meridian Capital’s Birnbaum cites a recent mall deal in the Southeast where an owner that lacked the equity for a refinance was able to tap the funds needed to meet loan coverage requirements with the help of a new equity partner.
Funding gaps are also spurring the revival of an old financing structure in which an owner slices off a portion of the property’s net operating income and sells it as a fee position. The remaining interest is held by the property’s owner, who then obtains a leasehold mortgage.
"I recently saw a transaction using this structure that netted the owner an additional $12 million to $13 million in proceeds," Birnbaum reports.
If all third-party sources of financing fail, there’s still one way to fund a transaction—seller financing.
"I’ve almost made it a requirement that a seller be willing to take back financing before I take a listing," Shapiro says. He recently sold a speculative office building to a buyer who put 25 percent down and financed the remainder with the seller over a five-year period.
"This gave the buyer time to construct and stabilize the property, then refinance or sell it," he explains. Seller financing also has the benefit of reducing initial tax liability for sellers with a significant capital gain, since portions of the gain can be allocated to each year that the seller is receiving payments.
Still Not a Stream
"The reality is that it’s not a lack of lenders or a lack of capital" that keeps many borrowers from getting a loan today, Hughes says.
"It’s a lack of properties that qualify under current underwriting standards." It may also help to realize that commercial real estate survived and prospered for years without 100 percent LTV, Shelton suggests. "Ten years ago, most loans required 25 percent or 30 percent down, and you rarely saw a nonrecourse loan. You had to have money to borrow." Like so much of the world today, everything old is new again.
A Revival of CMBS
They’re back. Commercial Mortgage Alert predicts that commercial mortgage-backed securities, which sold approximately $2.3 billion in new issues in this year’s first quarter, could exceed $20 billion in volume by year’s end. Of course, that’s only about 10 percent of the volume of CMBS issuance before the market fell apart in 2007, but don’t count CMBS out.
"With today’s underwriting reverting back to more traditional, conservative levels, conduit lenders think that on a risk/reward basis, commercial real estate offers a good return," says Constantine Korologos, managing director in the real estate practice at Deloitte Financial Advisory Services in New York.
Most mortgages structured to be sold as CMBS so far have been single-borrower loans with only a few large assets. Such deals are much more transparent and thus easier to underwrite, making them more attractive to wary investors.
"There’s a perception that larger, more diversified pools are a black box with unknowable risks," says Michael Mounts, who heads the real estate investment banking practice at Jones Lang LaSalle.
As of April 2010, there had been only one multiproperty, multiborrower CMBS deal, a $300 million offering issued by the Royal Bank of Scotland. Many CMBS watchers expect that more will come in the second half of this year.
And like all other lending sources, CMBS underwriting is loosening up.
"Underwriting is definitely moving in a positive direction," says Aaron Birnbaum, executive vice president with the Meridian Capital Group LLC in New York. "We’re doing a $30 million deal with a CMBS shop now that has 80 percent leverage."
So far, CMBS lenders are keeping many of these loans on their books, but that's likely to change, given the fact that CMBS offerings such as the $500 million J.P. Morgan Chase/Inland Western Retail Real Estate Trust Inc. deal were oversold, Mounts says. With that increasing level of interest, more CMBS are bound to be on the way.