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LENDERS GET CREATIVE AS MARKET HEATS UP

By Steve McLinden

Lenders are lining up in unprecedented numbers to pursue retail construction and investment deals again this year, making this a good time to borrow and walk away with plenty of concessions, said some loan brokers and lenders at ICSC’s Permanent Financing Outlook session at Spring Convention in Las Vegas. “If you’re a borrower, borrow as much as you can,” said Tom Whitesell, senior vice president for real estate at the Santa Monica, Calif., office of Fremont Investment & Loan. “Every lender is begging you to. … We have seen pricing drop down dramatically in the last six months.”

But panelists also warned that market fundamentals are not driving the commercial lending train — lenders are — and that the train could derail in the very near future, though probably with a softer landing than experienced in past financial industry corrections.

As was the case last year, all the popular debt and equity products, including direct, securitized and syndicated capital, are looking with conviction for real estate havens this year, a trend brought about by a flood of foreign capital, pension funds and traditional lending dollars looking for hard assets. The ongoing “extreme state of liquidity,” as one panelist called it, resulted in record sales volumes and prices last year, and that trend continues full force this year.

“The market will ultimately correct itself,” said Samuel Kirschner, managing director of New York City-based Hypo Real Estate Capital Corp. “The fundamentals are not supporting it. I know lenders out there who have doubled their lending volume in the last year, but their revenues are down 5 percent. That is not a sustainable model.”

Richard Katzenstein, senior managing director of New York City-based MMA Realty Capital, agrees. “It’s a frothy market,” he said. The current flood of capital “is changing the dynamics of the business. Spreads are coming in so tight right now that the benefits [are mostly] to the borrowers and the brokers.”

Katzenstein says he is troubled by the juxtaposition of rising interest rates and compressed cap rates. “Plus now,” he said, “the [lending] standards are much lower, and eventually when the proverbial stuff hits the fan, there’s going to be a lot of scrambling around.”

But a slightly softer landing is predicted by Michael J. Mazzei, managing director of New York City-based Barclays Capital. “If there is a correction, at least the markets are so liquid that the volatility — the highs and the lows — might get stripped out,” he said. “Unlike the early 1990s, when you said, ‘Oh no, what will you do with your real estate?’ to which the answer was: ‘Wait five years and dust it off,’ now, at least, things can trade out pretty quickly and you can adjust.” Investors fled to harder capital assets after corporate scandals cast a shadow over the stock market six years ago, he says.

“Real estate capital was the worst-performing asset in 1998,” said Mazzei. “In 2000, when Enron and WorldCom were blowing up, we turned that corner because investors didn’t know where in their portfolio the next blowup would be, so they ran to hard assets — real estate and asset-backed securities.” Domestic and foreign investors, he says, are coming in with real money to buy real estate, and they are not afraid to buy now, as they were during the 1980s and ’90s.

Kirschner sees a loose parallel between the current voluminous influx of capital “and what happened in the mid-to-late ’80s with the junk bonds. When we first got into that market, the rates were phenomenal, and, eventually, the market matured and found its level of water. … Eventually, when interest rates go up [this time], there’s going to be this rubber-band effect that’s going to snap back on us.”

As the market heats up, several creative lending tools are gaining in popularity, panelists said. One of these tools, the collateralized debt obligation, or CDO, has become especially desirable in retail lending. Essentially an investment-grade security backed by a pool of loans, bonds and other assets, the CDO does not specialize in any one type of debt. “It’s another new technology the high-priced guys on Wall Street came up with that allows you to borrow less expensively than in the past,” said session moderator Simon Ziff, president of New York City-based Ackman-Ziff Real Estate Group. Over the past decade, Ziff has managed and structured over $5 billion in equity and debt financing for developers and property owners nationwide. “It’s the next stage of securitized lending.”

Another product, the nonrecourse loan, has also gained a strong foothold in land investment, says Ziff. This structure, similar to a nonrecourse home mortgage, limits a lender’s rights to a land asset that is being financed. “Five years ago if someone came to me and said they needed a nonrecourse land loan, I’d tell them to go find another broker,” said Ziff. “But in the last three years, we have done over a billion in nonrecourse land loans.”

Whitesell advises developers and retailers seeking a construction loan to do their due diligence on the lender as well as on the property. “A good construction lender should be with you from the very beginning of the project to lease-up,” said Whitesell. “It is important to have construction people inside the bank who really understand what you go through as the borrower in the construction process, who understand title insurance, the process of getting permits and the true costs of that construction.”

By way of caution, though, he added, “Never does a deal go exactly as planned, especially during the construction side of the deal.”

Meanwhile, construction money is going out the door with a high-quality loan sponsor at about 150 basis points or lower, with as little as 30 percent preleasing and sometimes even without an anchor, panelists said.

“There are huge amounts of engines out there,” said Katzenstein, “that just need to put out product.”