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COVER STORY, MARCH 2005
LENDING LESSONS
Unique challenges and situations in the West put lenders’ loan types and services to the test.
Lara Fuller
While hot markets and popular property types seem to be perpetually changing, some of the biggest challenges many lending companies face are the individual loans that carry unique conditions and requirements. The manner in which a lending company handles a particularly significant deal is often indicative of the way the company operates as a whole. Several lenders from across the West recently spoke with Western Real Estate Business to discuss not only the status of western markets, but also about recent challenging transactions.
Unique Structure and Time Constraints
Chicago-based LaSalle Bank Corp. handles lending for a broad range of property types across the West, including office, retail, multifamily, manufactured housing, industrial, self-storage, hotels, single-tenant drugstores and student housing. The types of products the company offers range from standard conduit products to book floating rate debt to large loan securitized floaters.
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Loshbaugh |
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In a recent acquisition financing deal for the Gateway Pavilion, a 302,000-square-foot power center in Avondale, Arizona, “The borrower needed a very unique structure and was under tight time constraints that necessitated a guaranteed delivery,” says Josh Loshbaugh, associate director with LaSalle Bank Corp. LaSalle was chosen because of the company’s history of success and its ability to be flexible in both structure and timing. The challenges in financing the Gateway Pavilion were that the property was just being completed at the time of the closing, not all of the anchors were open for business and the inline space was still in lease up. In addition, the center was very large for the current market, and the borrower was looking for a 5-year, interest-only facility.
Faced with these circumstances, LaSalle’s approach focused on flexibility. “Due to the strong relationship with the borrower, the growth dynamics and unique deal structure, LaSalle was able to assess and mitigate the lease-up risk and timing of tenant occupation,” says Loshbaugh. “LaSalle leveraged its ability to utilize its balance sheet for a period of time to win the transaction and deliver the execution the client requested.”
When considering the feasibility of such a loan, the company generally looks at four main factors: historical operations, sponsorship, well-positioned assets within the submarket and sensible leverage. By using these criteria as a guide, LaSalle addresses unique deals and turns them into successful transactions.
A Quick Close
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Macedo |
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Last spring, Los Angeles-based Hanover Financial provided $16.25 million in mezzanine financing for a $161.5 million retail portfolio acquisition in Southern California. The borrower wanted to finance three retail centers separately, so Hanover turned to its Mezz Plus! Loan program. However, the transaction did not end there. One of the centers had environmental cleanup issues while another had a vacant anchor tenant. Hanover resolved the environmental issue when it determined that adequate reserves were held by the senior lender to meet the regulatory agency concerns. As for the vacant tenant, Hanover assessed the other in-place income with the expectation that the vacated space would be re-let in the short term.
“This deal was brought to us because the borrower needed a very quick close to meet the seller’s escrow demands,” says Mark Macedo, managing member with Hanover, which, in addition to retail, handles all types of incomeproducing property, including multifamily, office and industrial, across eight western states. “We were able to close the loans in less than 40 days.”
Friends in More Places
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Mendenhall |
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Q10 Capital, based in Salt Lake City, often relies on its national lending network to access the best capital sources for a particular project. “There was a high-profile property with a sophisticated borrower with high expectations and significant knowledge of the capital markets,” says Paul Mendenhall, president and COO of Q10 Capital. The national network was instrumental in finding the top capital sources in order to close the deal. “We not only met, but exceeded the borrower’s expectations and provided an exceptional loan for the project,” he says.
Though the company provides a wide range of loans, Q10 Capital has found that several loan products are particularly popular right now, including permanent first mortgage loans, construction financing with forward permanent loans and CTL loans. The company looks at three primary criteria — sponsorship, occupancy and location — in providing the borrower with the best possible financing options for the situation.
Two Loans at Once
New York-based CIBC prides itself on being a “one-stop shop” in regards to lending, financing all types of commercial property all across the West. A few of the loan types CIBC provides are construction, bridge, redevelopment and permanent. The company’s all-in-one philosophy was recently tested by a borrower needing both construction financing and a permanent loan for a Las Vegas multifamily development that was being constructed in two phases. The Las Vegas market is one with improving fundamentals, which makes lending a bit more difficult. However, CIBC was able to give them both the permanent and construction loans in approximately the same timeframe due to its comprehensive services and extensive experience.
When evaluating a deal like the one in Las Vegas, the company takes several things into consideration, including market fundamentals and strength. “We are looking to find markets that have stabilized in the particular property type,” says Andrew Fawer, managing director with CIBC. “That enables the client to capture the upside.” This approach and its “one-stop shop” setup have garnered CIBC a huge percentage increase in lending in the West in the last year.
A Risky Deal
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Kleen |
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Calabasas Hills, California-based ARCS Commercial Mortgage finances all property types, but is often known for its multifamily loans. One of ARCS’ recent multifamily transactions involved the 161-unit Little Tokyo Lofts, a recently completed loft property in Los Angeles that was still in lease-up at the time of financing. The $24.32 million complex featured 29,000 square feet of retail space, gated entry, security, swimming pool, sauna and Jacuzzi. “However, despite its high-end allure, it is located in a transitional neighborhood, meaning an area with a high crime rate,” says Kevin Kleen, senior credit officer with ARCS. The lender was able to get past these risk factors through its strong relationship with the borrower and its experience dealing with loft projects in Los Angeles. “We also had a lot of faith in [the borrower’s] managerial experience,” says Kleen, who points to the financial strength of the borrower, its experience in owning and managing property, as well as the job and economic growth of the area as key indicators of the success of a deal.
Whether financing a multifamily or other property type, ARCS is able to provide conventional and affordable housing loans; fixed rate and ARM loans; Fannie Mae, FHA and conduit loans; and first and supplemental loans.
A Multi-State Loan
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Grey |
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Though Crestridge Investments, based in El Segundo, California, works on deals across all areas of the West, much of the company’s emphasis is on California. However, Crestridge recently handled the $48.5 million acquisition of a 10-property self-storage portfolio that spanned five states: California, Arizona, Nevada, New Mexico and Texas. The challenge of providing a $5.64 million mezzanine loan for the acquisition was that it was high-leverage at 95 percent loan-to-value behind senior floating rate debt at 85 percent loan-to-value. “We were able to handle the challenge by underwriting the cash flow and valuation of the portfolio to satisfy the investment criteria on the mezzanine loan and by purchasing an interest rate cap on the senior floating rate debt,” says Christopher Grey, managing director with Crestridge Investments. The company was successful in closing the deal because it was able to provide the highest leverage available at the most competitive cost to the borrower, says Grey.
Crestridge Investments finances office, retail, multifamily, industrial and hospitality properties and provides mezzanine, participating debt, bridge and preferred equity loans. As for financing criteria, “Good sponsorship and track record is the most important,” says Grey. “Next we look at valuation of the underlying real estate against our investment criteria and make sure that there is sufficient equity contributed by the sponsor to make sure our interests are aligned with theirs.”
One Deal Turns Into Multiple Deals
Southern California and Phoenix are popular markets right now, and that is where Mountain Funding is doing a majority of its lending. Focusing mainly on retail and residential properties, the Charlotte, N.C.-based company offers flexible structures to meet the needs of its clients, including mezzanine loans, high-leverage one-stop whole loans, preferred equity and pure equity, in addition to hard money and budget loans. “The common thread in all of our projects is that they are all value-added situations,” says Arthur Nevid, managing director with Mountain Funding. “We are not a permanent lender. Instead, we help developers get from point A to point B, increase their cash flow and value, and then take us out with conventional permanent debt.”
The company recently handled a $6 million mezzanine loan transaction for a 287-acre parcel of land in the Arroyo Seco project in Buckeye, Arizona. Novi, Michigan-based Crosswinds Communities purchased the land, which is located adjacent to the master-planned community of Verrado. Mountain Funding’s cross-country growth is a testament to how quickly a single deal that is handled well can multiply into other lucrative deals.
Two Types of Financing
Though a national company, Los Angeles-based Pacific Coast Capital Partners (PCCP) focuses mainly on California. In San Diego, the company recently formed a joint venture with Stoltz Real Estate Fund to purchase Plaza Las Americas, a 46.8-acre retail property. The property is part of a 66-acre, 1.4 million-square-foot mixed-use development known as Las Americas, located in a low-income census tract in San Diego County. “It was one of the largest retail deals done in the western U.S. in the last year,” says Jed Lassere, vice president with PCCP.
PCCP provided both the debt and equity in the transaction and the company’s lending arm, Redwood Capital Finance Co., provided the acquisition financing. PCCP plans to operate the first phase of the project and finance the development and lease-up of the second phase. The company hopes this transaction will spur additional development and economic growth in the area. “People choose to do business with PCCP because of our fast response time and competitive non-recourse pricing,” says Lassere.
The company also provides bridge, LIBOR-based and floating-rate loans, and finances office, retail, multifamily, residential, industrial and mixed-use, with office and retail holding much of the company’s attention right now. “Transitional retail and office has been our focus in early 2005, along with continued residential opportunities,” says Lassere, who asserts that the biggest lending criteria for PCCP have to do with the borrower. “The experience of the borrower is always key for us. The nature of bridge financing is such that we like to see a strong borrower capable of bringing in the collateral out of the transitional phase.”
Current Market Conditions
One market with a steady stream of opportunities is Southern California. The region continues its run as a hot market, attracting both investors and lenders.
“Southern California remains incredibly strong for all asset classes,” says Loshbaugh. Macedo agrees, adding, “Across the property class spectrum, Southern California remains a very attractive investment environment.” Mountain Funding’s Nevid also puts Southern California above most markets in the West, citing San Diego in particular.
There are several other western markets that are predicted to do well during the next couple of years, including Seattle, Portland, Salt Lake City, Honolulu, Las Vegas and Denver. “There are a few surprising results — Seattle appears to be emerging and represents appealing opportunities in office, industrial and apartment markets,” says Macedo.
In some cities, a single property type garners most of the attention. For example, hotel properties are beginning to turn around in some markets that are still slow overall. “Hotels, both full and limited services, are becoming a more favorable asset class, and lenders’ appetites are coming back,” says Loshbaugh. Fawer cites the $40 million Westin hotel in Westminster, Colorado, as proof.
And while office is still lagging in many cities it is doing okay in others. “Some property types, such as office in certain markets, are struggling, but capital is still chasing it,” says Grey. Office is turning the corner in San Francisco, Seattle and Phoenix, says Loshbaugh. Fawer adds Seattle to the list of improving office markets and Macedo is seeing a turnaround in Honolulu’s office market.
In regards to multifamily, Macedo has seen Northern California’s market strengthen, Fawer predicts Arizona will do well and Loshbaugh is seeing more activity in Denver. “Denver is experiencing a tremendous amount of growth and is changing into a 24-hour city,” he says.
In most cities, retail often remains one of the stronger property types, even during economic low points. “Retail is doing well across the board,” says Fawer. “There are few areas of concern when it comes to retail.” Phoenix is one city in particular where retail is gaining strength. “Retail projects in suburban Phoenix are very hot right now,” says Loshbaugh.
The Outlook
Most lenders expect to feel the predicted increase in interest rates, but market effects will vary. “We have seen increasing rates during the latter part of 2004 without significant impact on commercial real estate financing,” says Mendenhall. “We feel the market can still see increases without materially affecting financing.”
As the year progresses, “It is our expectation that interest rates will continue their gradual rise,” says Macedo. “This will put increasing stress on the ability of assets to service the underlying debt, but in many markets, especially Southern California, we expect rent growth to keep pace with interest rate escalation.”
According to Nevid, there won’t be much change if increases in interest rates remain slow, as they have been. “But overall, increased interest rates will put strain on cash flows and ability to service high-leverage senior loans. This will result in greater need for mezzanine debt and will also ultimately push cap rates back up to rationale levels.”
Adds Loshbaugh, “Long term interest rate increases are certain to have an effect on proceeds, as strong properties are often being financed at already tight actual coverage levels. Cap rates should stay low, due to the enormous amount of capital chasing deals, but should rise moderately with a sustained increase in long term rates. Short-term rates have increased substantially, which has moved some borrowers off of their floating rate loans in favor of still attractive long-term fixed-rate financing.”
Lassere predicts a slowing in some previously booming markets. “A significant increase in interest rates will likely slow down the small industrial building for-sale market that was very hot in 2004,” he says. “As rates rise, the rent-versus-own debate will clearly favor renting, as has historically been the case for commercial ventures.”
For ARCS, the increase in interest rates is a potentially good thing. “Since we finance a lot of multifamily, an increase in interest rates could actually be of benefit,” says Kleen. “Low interest rates have fueled the exodus out of apartments and into private homes. With occupancies down in many markets, deals were harder to get done.”
Whatever happens in regards to interest rates and the current market, lending companies will still base much of their lending on individual circumstances. Much of a company’s success comes from the ability to deal with unique situations.
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