COVER STORY, FEBRUARY 2007

LENDING LOWDOWN
Experts discuss the West.
compiled by Brian A. Lee

WREB: What loan products are particularly popular right now?

Davis

Davis: Driven by historically low interest rates, commercial lenders continue to set record volumes in permanent loan production. Permanent fixed-rate-term debt remains the borrowers’ most popular choice for standard refinancing. In addition, acquisition and bridge financing remain readily available as the transfer of properties continues to occur at a robust pace. The number of lenders providing mezzanine financing has also increased, as this financing strategy has become widely popular as a method for borrowers to leverage their properties above traditional 75 to 80 percent values.

Tenzer: It is difficult to pinpoint specific product types that are popular. The diversity of the real estate industry requires a very broad profile of loan types and structures, each with their own specific relevance to the financing environment. The popularity of the loan depends on the needs of the borrower and the requirement of the project. And with such a diverse pool of borrowers, these needs are constantly changing. In 2006, we saw an increased percentage of structured transactions with opportunity funds, hedge funds and CDOs.

Sherlock: Fixed-rate loans that are essentially bridge loans are very attractive right now because of the inverted yield curve. Borrowers are paying in the upper 5-percent, low 6-percent range with obtainable earn-outs as opposed to floating rates in the 7-percent-plus starting range. If there is negative amortization associated with the loan structure, investment rights can significantly minimize that cost.

WREB: What property types are hot/not?

Davis: Multifamily has been the hottest property type in the last few years. Cap rates for multifamily properties continue to be historically low, driving many transactions and creating an abundance of multifamily loan opportunities.

In addition, activity on grocery-anchored retail properties increased dramatically from 2005 to 2006. Centers anchored by a grocery are much preferred to lenders since they are often credit tenants, sign long-term leases and are a destination tenant, driving traffic to the rest of the site.

Tenzer

Tenzer: Of the four main product types, apartments have remained very strong, particularly in areas of solid rental growth such as Southern California. Since there is a very high level of competition in this market, cap rates have remained low. Additionally, institutional quality property has been hotly contested throughout the West, and investment grade property has also gained a significant market share.

Tenzer: Industrial warehouse space is benefiting from international trade traffic, which we expect to remain strong. Restrictions on foreign trade would, however, create risks to warehouse demand.

We also anticipate that the weakness in single-family housing and strong employment will support multifamily housing demand. However, stalled condo-conversion projects returning to the rental market pose some risks to multi-housing.

WREB: What markets of the West are hot right now?

Davis: The California market is especially hot, including the San Diego area. Outside of California, we’ve seen an abundance of activity in Las Vegas, Phoenix and Denver.

Tenzer: While the slowdown in the residential market has had a substantial effect on many of the secondary markets, activity in the major cities remains strong, with the exception being a softening in the high-rise condo market in overbuilt markets such as Las Vegas and San Diego. In 2007, infill projects will garner a much higher level of interest than land acquisitions.

Sherlock

Sherlock: The Inland Empire has been growing extremely fast. Most of the areas in Southern California have been performing well, but the Inland Empire will continue to lead within the area.

Las Vegas and Phoenix continue to represent top population and job growth markets. Nevertheless, the slowdown in single-family housing will cause the smaller companies associated with the residential market to struggle. This may pull some demand away from offices in Phoenix; however, this region is well poised to become a major distribution hub for the Southwestern United States. Boise, Idaho, would qualify as an emerging market. The influx of people, in relative terms, and high job growth has placed Boise on the radar screen.

WREB: How do you think the lending environment will change during 2007?

Davis: The lending platform will continue to be very strong and aggressive. This year will generally be a continuation of 2005 and 2006, each of which were record-setting years. Lenders will remain aggressive and keep pushing the envelope on underwriting parameters in order to win business. As a whole, expect a further increase in Collateralized Debt Obligation (CDO) business as the large number of transitional properties seek a flexible home for their permanent debt. 

Tenzer: Despite some concern regarding rising interest rates, they should remain relatively close to where they are now. Long-term rates may inch up, but we are not predicting a dramatic change. With regard to capital flow, the markets are still flush with capital; however, the ability to successfully place it will be contingent upon recognizing and implementing the capital structures that best align with the strategic and tactical objectives of the investment strategy. As a result, financial intermediaries must take a two-fold approach that employs the strategic expertise of how to structure a loan and the tactical know-how of how to get it financed quickly and efficiently.

Sherlock: We expect a slight slowdown in capital flows in 2007. Federal regulators have recently finalized guidance on commercial real estate lending. Capital flow will unlikely stall, but lenders will have more stringent underwriting standards. The Fed may lower fed funds rates toward the end of 2007, depending on the level of the economic slowdown and inflationary pressures. The tight labor market remains a concern for the Fed, which may otherwise raise rates if wage inflation becomes more apparent. Longer-term rates will also depend on foreign demand for Treasuries. For the most part, Treasuries will react to economic reports. We expect 10-year Treasuries to hover in the upper 4-percent to low 5-percent range in 2007.

WREB: What role does creative financing play in your company’s growth strategy in the region?

Davis: We recently worked with a client that was acquiring two apartment communities in the Southwest. The acquisitions actually closed in 2005, at which time the properties had substantial deferred maintenance and elevated vacancy rates. The client needed acquisition/renovation funds, which Collateral provided through its affiliate, New South Federal Savings Bank. The client completed the renovations in 2006, leading to dramatically improved operations. One of the properties was ready for permanent financing before the other and Collateral presented that opportunity with specific investors, and a GSE (government sponsored enterprise) source provided the best deal for the client. When the second property was ready for permanent debt, Collateral again presented the opportunity to a group of specific investors, fully expecting to complete the financing with the same investor. However, the market conditions had changed and a CMBS lender provided the best execution. If our client had been working with a firm that did not represent a wide variety of capital sources, the client could have received an inferior capital structure on the second assignment.

Tenzer: Previously viewed as a financing novelty, creative financing is now a mainstay in the real estate industry. The number of capital sources is greater than ever before and there is an array of new tools at our disposal to assist in placing this capital. As a result, structured finance is now one of the most frequently employed and sought after methods of finance.

One great example of the growing need for creativity in financing occurred when we handled the acquisition financing for 22 acres of industrial zoned land in Kapolei, Hawaii, for the development of a proposed movie studio. A traditional lender would not provide this type of financing, as the existing parcel was not subdivided and we were unable to obtain a deed of trust. The transaction was highly atypical — we arranged the 100-percent-of-cost financing with a private family trust, whose sole collateral was a pledge of a prospective ground lease, which provided the buyer with an option to acquire the fee interest in the land at a significant discount to the market value. The success of this financing was contingent upon the ability to think outside of the box and provide a solution that would meet the unique needs of the borrower.

Sherlock: Our company was built around creative financing structures. Our discretionary joint venture equity funds are value-add oriented and are well known as fast and creative investors for the right operating partners and transactions. Our advisory team has a reputation for creative financing structures on behalf of clients like Hines, Lowe Enterprises and Birtcher Development & Investments. From high leverage debt to forward-equity commitments and tri-party institutional pre-sales, we have helped create opportunities on behalf of clients.


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