In the Fall of 2008 Private Real Estate Lenders (both hedge funds and private equity funds) are actively taking up the slack in the wake of the retreat of many banks from the lending landscape. They are providing liquidity to commercial real estate owners and developers allowing transactions to close, deadlines to be met, as well as to keep 1031 tax-free exchanges from blowing up. While for the moment the guns of the big investment banks have gone silent, these private sources of real estate capital are becoming a financing solution that is being utilized increasingly by mainstream owners and developers.
Of course, some of these private funds are making/have made stupid loans and will go/have gone out of business. Others will remain disciplined and choose to lend on only the best of the deals offered to them. Investors in these funds (many of whom are currently getting killed in the stock market) are delighted to have a highly collateralized, diversified investment delivering double-digit net returns that are not correlated to the stock and bond markets. W Financial Fund, LP has seen such an increase in demand from investors that it has launched a new share class to better serve both institutional and high net worth investors, effective September 1st, 2008.
Underwriting on Steroids
For those banks still making loans, it seem that nearly every aspect of their underwriting criteria has been ratcheted way up to a level high enough to ensure that the loan officer won’t get laughed out of the bank’s loan committee meeting. No loan officer wants to internally champion a deal only to have his “baby” shot down. Banks are not currently looking to their loan officers to be aggressive. Quite the opposite. So the only way to successfully overcome this considerable negative inertia is with very compelling data such as serious sponsor net worth and liquidity, an incontrovertible track record and experience, not to mention a standout location (i.e., if it’s “Park Slope”, Fourth Avenue is not Seventh Avenue, etc.). Each element of the deal, most especially for prospective construction loans, needs to be beyond reproach: the prospective loan-to-cost needs to be lower, while the net worth and liquidity of the developer needs to be higher. Loan officers at the major banks will parse through each element visualizing presenting the deal at loan committee knowing well what will, and what won’t make it through the gauntlet. Any commercial mortgage broker or intermediary that lacks the experience and ability to assist a borrower in seriously beefing up their game plan and presentation will not last long in the thin air of the current credit environment. The days of throwing a deal at the wall and hoping it will stick are gone for now - and most likely they’re gone for the foreseeable future.
These days the maximum proceeds that you are going to see on a residential or mixed-use development loan will be limited to a percentage of the as-completed, stabilized rental value of the property, which for most lenders will not exceed 75%, and for some could be lower. The resulting loan-to-cost will certainly be much lower than the once-common 80% LTC that many of us remember so well.
Lender vetting of sponsor qualifications has, not surprisingly, been hugely beefed up. Rookies need not apply. Being a “real” developer actually means something again. The proven ability to expertly execute a complex development project, and to expertly market, sell or rent it, is essential to obtaining construction financing. Is this a bad thing? I don’t think so. Furthermore, virtually every development deal will require some level of personal recourse.
Since banks are not currently in a mood to be adventurous, no loan committee is particularly excited about getting in on the ground floor of the “next great market”, although surely, once some undefined tipping point is reached, banks will again become susceptible to the lure of places
(like for example, East Williamsburg) that are up-and-coming and might come in to their own some day.
Even after the current credit crisis has finally run its course and begins to release its strangle hold on the credit markets (let’s say by late 2009 or early 2010) I seriously doubt that underwriting standards will drop to their previously weak levels.
Not only has the rising tide that once lifted all boats now retreated; the beach is now littered with boats and debris waiting to be lifted by the next rising tide. No bank that I’m aware of is currently underwriting some brighter, shinier future. The banks (meaning the 40% or so of banks that were once very active that are still more or less in the market today) are confronting reality as it stands now. If anything, they are assuming flat or slightly negative growth. They are not underwriting any pie in the sky deals or assumptions. In this kind of market no bank loan officer every gets fired for saying no. That, of course, will eventually change. Sooner or later the reality will set in that the pipeline of new projects has thinned so much that even a modest uptick in demand will rapidly consume all available supply. Once that concept dawns on them, it will filter down from the bank chairmen to the loan officers and the banks will again become aggressive, not wanting to be left behind their peers. Meanwhile some smart, smaller banks are having their best year ever and getting the pick of the litter.
As mentioned earlier, some deals are being funded by bridge loans provided by private lenders that are serving to keep the heart of commercial real estate beating until the blood flows back into the veins of the banks. Because of this, they are gaining a solid foothold and a reputation as meaningful players. As the private lenders grow bigger over time, they will be able to offer lower pricing (most bridge lenders typically charge nearly twice as much as banks for short-term bridge loans, say 12% rather than the 6% or 7% charged by banks today). Having gained a reputation for quick, intelligent underwriting, reliability and speed, the private lenders will continue to offer a real alternative
to using banks. Many savvy borrowers will continue to use the private lenders for their short term needs, and use the banks for longer term needs such as permanent loans on cash-flowing properties.
