Success Stories
It pays to know what lenders want to hear.
By Gary Mozer for CIRE Magazine
During the past six months, commercial real estate capital has re-entered the market after almost a two-year absence. Capital providers are eager to deploy their funds. They are increasingly inclined to consider speculative leasing, secondary markets, sub-institutional-quality assets, and midmarket sponsors.
However, caution prevails. And after the long dry spell, competition for capital is steep. Thus, any financing that requires capital to leave the fairway must demonstrate a compelling reason for investment. In short, you have to tell a strong story. Capital providers need to know why the deal deserves to be financed.
Furthermore, the current marketplace of capital providers is inefficient. Finding the right source requires diligence, and it pays to know a capital provider’s hot buttons before presenting, especially as appetites are evolving.
Investment Drivers
Capital is generally looking for one or more of the following major drivers in transactional financing.
Quality cash flow with strong credit and a long-term income stream. George Smith Partners secured financing for construction of a medical facility that is 100 percent pre-leased to an investment-grade tenant.
A nonspeculative need. For example, new multifamily construction in a tertiary market was financed based on dramatic undersupply of housing and strong local job growth, as evidenced by long-term residential leasing among local hotels.
Recapitalization to a “new-paradigm” basis. Low-cost basis allows lower rents to steal market share from competitors — even if the market is in equilibrium. An office building was recapitalized at a reduced-cost basis, allowing the sponsor to pro forma rents below market and thereby retain and attract tenants.
Repayment guaranty to a large, low-leverage, and highly liquid balance sheet. GSP secured financing for a class B industrial facility with substantial lease roll and noncredit tenants, premised on the lender’s comfort with the sponsor as a source of repayment.
Happy Endings
There are two important caveats to this optimistic outlook. First, the old financing paradigm of high-leverage, nonrecourse capital at low rates no longer exists. Assets are being de-levered. Refinancing debt typically demands a new cash contribution. Recapitalizing mezzanine or equity typically demands a write-down or subordinated interest. Second, any weakness in the sponsor, real estate, or market must be offset by another factor. Below, these types of risk mitigation measures are highlighted using the aforementioned examples.
Medical facility. Special-purpose construction with a relatively ordinary sponsor balance sheet was acceptable because the cash flow upon completion was secure. GSP arranged a loan at 75 percent of cost with a 5.25 percent starting rate.
Multifamily construction. New construction in a tertiary market was acceptable because of a dramatic imbalance in supply and demand and a strong sponsor signing recourse. The buyer’s financing was a three-year, nonrecourse loan at a 4.5 percent starting rate, with a 1 percent origination fee and 1 percent exit fee on a 65 percent advance.
Class C asset. Located in a secondary market with significant rollover, this industrial transaction succeeded based on a competitive advantage in cost basis. Although the loan was nonrecourse, the institutional sponsor had a history of delivering on its business plan and was known to be a good operator. In addition, the property was meeting a significant need in the market, so it was highly likely that all tenants would renew as there was no other product in the market. GSP arranged 65 percent loan-to-value debt for five years at 5.5 percent.
Class B industrial. Finally, a B-quality industrial facility with substantial lease roll and noncredit tenants succeeded premised on the sponsor’s guaranty. The financing was 65 percent LTV floating for five years with a 4 percent starting rate.
Clearly, if you have the right story — and you know how to tell it — you can find capital in this slow-moving market. Competition is fierce and capital providers can afford to be choosy. You may have to talk to 50 people before you find one who wants to invest, but all you need is one who is willing to listen and take action.
