Texas Real Estate Business

FEB 2018

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

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Ernest DesRochers NorthMarq Capital 28 • February 2018 • Texas Real Estate Business www.REBusinessOnline.com But intermediaries fear that transac- tions could further stall given the prob- ability of rising interest rates as the economy heats up and the Federal Re- serve hikes the federal funds rate and unwinds some $4.5 trillion of assets on its balance sheet that it amassed during quantitative easing. The benchmark 10-year Treasury yield ended 2017 near 2.5 percent after generally hovering between 2.2 percent and 2.5 percent for the year with a few bouts of volatility. But the question is whether sellers, faced with higher capi- talization rates if interest rates indeed rise, will adjust their expectations. "If sellers can't get their cap rate, will that further dampen their appetite to sell?" asks Francis, who is based in CBRE Capital Markets' Phoenix office. "What are they going to buy if they can't get the price that they could have six months ago?" A recession-signaling inversion of the yield curve and ever-present geo- political dangers also threaten invest- ment sales activity. The gap between yields on the two-year and 10-year Treasury notes flattened to around 50 basis points early this year, one of the lowest levels since 2007. Meanwhile, from North Korea to Iran, the possibility of upheaval lurks in numerous global locations and could bring the securitization market to a standstill, Knight warns. "When the tsuna- mi hit Japan, CMBS shut down," explains Knight, whose office originated some $2.7 billion in 2017, up $1 billion over 2016. "We've seen a lot of stability in the CMBS market, but all it takes is some event or somebody start- ing a conflict to restrict capital flows to real estate." Refinance Alternative In some cases, the stalemate between buyers and sellers has already con- vinced owners to bypass a sale and instead refinance, often to pocket some appreciation or to pay off an equity 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 in 2017 and is opening an of- fice in Detroit, where it placed $400 mil- lion 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 pro- grams offered by Fannie Mae and Fred- die Mac, says Blumberg of NorthMarq Capital. The green programs, which can also finance acquisitions, typically provide a higher loan-to-value (LTV) 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 refinanc- ing for the owner of the 533-unit Co- lumbus Plaza apartments in Chicago. The seven-year, interest-only loan fea- tured a mid-3 percent floating interest rate, says Blumberg. "We maximized the proceeds and reposition the prop- erty 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 dis- playing an uptick in rent concessions and slowing rent growth, including Denver, Nashville and Atlanta. Con- sequently, lenders are making less ag- gressive income projections than they were several months ago, when they often would annualize one month of trailing income, says Daniel Rosen- berg, a managing director with Chica- go-based Cohen Financial, a division of SunTrust Bank. Debt providers are approaching ho- tels similarly after years of new supply in many markets and years of improving performance, mort- gage bankers say. The industry profit gauge of revenue per avail- able room (RevPAR) of $75.48 in Novem- ber marked the 93rd straight month of growth, according to Hendersonville, Tennessee-based hospitality researcher STR. The average 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 underwrit- ing the deals at today's peak environ- ment 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 general exceptions of urban infill projects and grocery-anchored centers. But even that is changing, mortgage bankers say. "Grocery-anchored centers were abso- lutely bulletproof — at least up until Amazon bought Whole Foods Mar- ket," says Ernest DesRochers, a manag- ing director with NorthMarq Capital in New York City. Meanwhile, office buildings continue to attract lenders, even value-add proj- ects in the suburbs. In suburban Phoe- nix, for example, an institutional buyer of a three-story office building with roughly 35 percent vacancy ultimately received financing from a bank with a prior relationship after the deal was shopped to 60 lenders, says Francis of CBRE Capital Markets. The loan had a LTV ratio of 65 per- cent, an interest rate of 230 basis points over one-month LIBOR and other fa- vorable 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 offer," advises Francis. "It's competitive." n Tucker Knight Berkadia Daniel Rosenberg Cohen Financial Upon the introduction in 2015 of new banking regulations related to holding extra reserves for short-term or riskier commercial real estate loans, banks reined in lending. While the pullback affected prop- erty investors across the board, de- velopers 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 (Lon- don Interbank Offered Rate), and the number of banks that would consider development financing plunged, say mortgage bankers. In 2017, the number of banks will- ing 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 nota- ble change in 2017 was the growth in debt fund activity," says Kathy Farrell, head of commer- cial real estate for Atlanta-based Sun- Trust 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 re- search firm Preqin, 47 global real es- tate debt funds raised a record $28 billion in 2017, up from 32 funds that raised $19 billion in 2016. Debt fund sponsors include Brookfield Asset Management, Prime Finance, Black- stone and Oaktree Capital Manage- ment, 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, man- aging director for Los Angeles-based George Smith Partners. The firm ex- pects 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 tradi- tional lenders, typically charging in- terest rates of 350 to 500 basis points over LIBOR, says Wally Reid, a senior managing director with HFF in Hous- ton. The added expense virtually shut down merchant building. An extra 100 basis points on a $40 million con- struction 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 Capi- tal Markets. Among other deals, at year-end Francis was arranging financing for a non-institutional, value-add office buyer in Phoenix through a debt fund, which was providing a 70 percent loan-to-value ratio and an interest rate of 300 basis points over LIBOR. "We've seen so many additional en- trants 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 financ- ing gaps left by banks. In July, George Smith Partners tapped an offshore investor for $21.6 million in non-re- course financing to develop a 35-unit condominium project with ground- floor retail in the Silver Lake neigh- borhood of Los Angeles. The borrower received 80 percent of the project cost in a two-year loan with an interest rate of 10 percent. "Even with condo construction de- fault liability of 10 years in California, the fact that units are coming out of the ground shows that there's de- mand for the product," says Lee. Joe Gose TIGHT BANK REGULATIONS OPEN DOOR FOR ALTERNATIVE LENDERS Jonathan Lee George Smith Partners Kathy Farrell SunTrust

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