Heartland Real Estate Business

FEB 2018

Heartland Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Midwest.

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26 • February 2018 • Heartland Real Estate Business www.REBusinessOnline.com convinced owners to bypass a sale and instead refinance, often to pocket some appreciation or to pay off an eq- uity partner and bring in another as part of a recapitalization. Owners following that formula in- clude value-add investors and those who bought early in the recovery, ex- plains Dennis Bernard, founder and president of Southfield, Michigan- based Bernard Financial Group. The firm generated more than $1 billion in commercial real estate loans across Michigan for the fifth year in a row in 2017 and is opening an office in De- troit, where it placed $400 million in debt last year. "Borrowers want to take money out, and lenders are allowing cash-out re- financing, but they're conservative," says Bernard. Multifamily owners who want to re- finance and enhance their properties are increasingly tapping into green programs offered by Fannie Mae and Freddie Mac, says Blumberg of North- Marq Capital. The green programs, which can also finance acquisitions, typically provide a higher loan-to-value ratio, a lower interest rate and other favorable terms if landlords upgrade appliances, HVAC and other systems to reduce a property's annual energy or water use by 25 percent. In December, Blumberg finalized a $93 million Fannie Mae green refi- nancing for the owner of the 533-unit Columbus Plaza apartments in down- town Chicago. The seven-year, inter- est-only loan featured a mid-3 percent floating interest rate, says Blumberg. "We were able to maximize the pro- ceeds and reposition the property for a long-term loan," she explains. "The payback takes about a year, so who wouldn't use the programs?" In and out of favor When it comes to acquisition financ- ing, loan terms vary depending on property type, location, sponsorship and tenants. Lenders largely remain bullish on multifamily and industrial properties driven by e-commerce. The tenant demand and property funda- mentals remain strong in those two sectors. But some apartment markets are displaying an uptick in rent conces- sions and slowing rent growth, in- cluding Denver, Nashville and Atlan- ta. Consequently, lenders are making less aggressive income projections than they were several months ago, when they often would annualize one month of trailing income, says Daniel Rosenberg, a managing director with Chicago-based Co- hen Financial, a di- vision of SunTrust Bank. Debt providers are approaching hotels similarly after years of new supply in many markets and years of improv- ing performance, mortgage bankers say. The industry profit gauge of rev- enue per available room (RevPAR) of $75.48 in November marked the 93rd straight month of growth, according to Hendersonville, Tennessee-based hospitality researcher STR. The av- erage occupancy and daily rate also grew. "Acquisition financing with a flag in a major market is easier to get than for a boutique hotel," Rosenberg says. "But lenders are looking at cash flow more critically, and they are not un- derwriting the deals at today's peak environment but are trending down to, say, 2014 as a baseline." Not surprisingly, lenders are gun- shy about retail properties amid the e-commerce disruption, with the gen- eral exceptions of urban infill projects and grocery-anchored centers. But even that is chang- ing, mortgage bank- ers say. "Grocery- anchored centers were absolutely bulletproof — at least up until Ama- zon bought Whole Foods Market," says Ernest DesRochers, a managing direc- tor with NorthMarq Capital in New York City. Meanwhile, office buildings contin- ue to attract lenders, even value-add projects in the suburbs. In suburban Phoenix, for example, an institutional buyer of a three-story office building with roughly 35 percent vacancy ulti- mately received financing from a bank with a prior relationship after the deal was shopped to 60 lenders, says Fran- cis of CBRE Capital Markets. The loan had a loan-to-value ratio of 65 percent, an interest rate of 230 ba- sis points over one-month LIBOR and other favorable terms, he adds. "Borrowers need to take their deals out wide and deep because you don't know who that outlier might be that raises its hand and makes a great of- fer," advises Francis. "It's competi- tive." n Restrictive bank regulations open door for alternative lenders Upon the introduction in 2015 of new banking regu- lations related to holding extra reserves for short-term or riskier commercial real estate loans, banks reined in lending. While the pullback affected property investors across the board, developers felt it most. Typical loan-to-cost ratios for construction financing dropped 20 percentage points to 55 percent, interest rates ballooned by some 150 basis points to around 350 basis points over 30-day LIBOR (London Interbank Offered Rate), and the num- ber of banks that would consider development financ- ing plunged, say mortgage bankers. In 2017, the number of banks willing to look at potential deals grew and interest rates dropped some, but leverage generally remained capped at 65 percent of costs. Consequently, borrowers more than ever are tapping non-bank lenders, particularly private debt funds. "The most notable change in 2017 was the growth in debt fund activity," says Kathy Farrell, head of com- mercial real estate for Atlanta-based SunTrust Banks. "They certainly stepped in to fill the gap in construction and acquisition financing created by the pullback of the banks." According to alternative asset research firm Preqin, 47 global real estate debt funds raised a record $28 bil- lion in 2017, up from 32 funds that raised $19 billion in 2016. Debt fund sponsors include Brookfield Asset Management, Prime Finance, Blackstone and Oaktree Capital Management, to name a few. Investors in the funds are aiming to protect down- side risk in a peak-value property environment and are happy to reap yields of around 9 percent versus tak- ing equity risk for higher returns, says Jonathan Lee, managing director for Los Angeles-based George Smith Partners. The firm expects to originate some $2.5 billion in financing this year, up from $2 billion in 2017. Initially, however, debt funds were much more expensive than traditional lenders, typically charging interest rates of 350 to 500 basis points over LIBOR, says Wally Reid, a senior managing director with HFF in Houston. The added expense virtually shut down merchant building. An extra 100 basis points on a $40 million construc- tion loan adds another profit-eating $1.2 million in annual interest, he explains. But over the last year, debt fund spreads over LIBOR have contracted by 100 to 150 basis points, says Bruce Francis, vice chairman of CBRE Capital Markets. Among other deals, at year-end Francis was arrang- ing financing for a non-institutional, value-add office buyer in Phoenix through a debt fund, which was pro- viding a 70 percent loan-to-value ratio and an interest rate of 300 basis points over LIBOR. "We've seen so many additional entrants into that market, and I think to a large extent the funds will remain a big story in 2018," Francis notes. In addition to debt funds, foreign capital has also closed some financing gaps left by banks. In July, George Smith Partners tapped an offshore investor for $21.6 million in non-recourse financing to develop a 35-unit condominium project with ground-floor retail in the Silver Lake neighborhood of Los Angeles. The borrower received 80 percent of the cost of the project in a two-year loan with an interest rate of 10 percent. "Even with condo construction default liability of 10 years in California, the fact that units are coming out of the ground shows that there's demand for the product," says Lee. — Joe Gose Daniel Rosenberg Cohen Financial Ernest DesRochers NorthMarq Capital The $93 million Fannie Mae green program loan for the refinancing of Columbus Plaza in Chicago features a mid-3 percent floating interest rate. The borrower also used the loan to upgrade energy and water systems at the apart- ment tower.

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