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Are Any Deals Getting Done?
The relatively short and volatile history of the credit crisis and recession might roughly be divided into two periods: before Lehman Brothers’ bankruptcy in September ’08 and after. While obtaining financing had been dicey prior to that, it became even more difficult after.
So perhaps Golub & Co. was fortunate that when it decided in August ’08 to seek refinancing for 22 West Washington, a 400,000-square-foot, 17-story office building in Chicago, it was able to find it with ING Real Estate Finance U.S. Golub president and CEO Michael Newman noted that most lenders at the time said that they liked the deal but couldn’t put the money out, while some banks wanted to syndicate it.
With BlackRock as a capital partner, the company had a construction loan from Bank of America and had planned to refinance or hold and ultimately sell the property. But as credit conditions declined, the company made the judgment call that it would seek more than $100 million in financing versus waiting and hoping that market conditions would improve. ING offered the best package, said Newman (though he declined to report the terms).
“It was a pretty reasonable LTV, but it wasn’t like a few years ago; it took out the construction loan,” he said. The rate did change during the process and Newman observed that “time will tell if it’s a good deal or not.”
Golub & Co. first got involved with the site a few years ago, when it acquired development rights to the office component of Block 37 from the Mills Corporation. It completed the building in June 2008 --- the first new commercial development to open on the site in 25 years. The building is more than 80 percent leased to CBS, Morningstar and Sterling Business Centers.
Conventional wisdom, post-Lehman, is that underwriting standards for commercial real estate have tightened, low leverage is de rigeuer and creditworthiness is paramount. But that doesn’t tell the whole story; the actual number of financing or refinancing transactions being done has slowed to a trickle. As Patrick Minea, senior vice president and managing director of the Minneapolis office of NorthMarq Capital, Inc., explained, this company’s current bread-and-butter deals mostly involve apartment financing.
“We’re not getting clear signals from the life companies as to how they want to proceed,” said Minea. Where financing is available, the leverage range is more often 50 to 60 percent. Determining value is a constantly moving target, so “it’s a deal-by-deal environment,” he said. “Lenders can cherry-pick. Rules are being rewritten as we go. Deals that need creativity are being put aside.” He believes that lenders are trying to keep their powder dry, considering worst-case scenarios involving none of their loans being paid off in ’09.
“That feeds into the liquidity crunch,” he said. Like many other organizations, NorthMarq is looking at the possibility of creating a fund to acquire distressed debt. But that is “easier said than done.” In the meantime, he noted that “the best thing we can do is educate the borrowing community: this is the world and if we tell you this is a deal you should take, you should take it. Those quotes don’t last long. Spreads move daily.”
Asked what kinds of deals are getting done, Russell Schildkraut, principal and head of underwriting and placement at Ackman-Ziff Real Estate Group, said, “nothing, except for residential, through government agencies,” although he did acknowledge that some transactions involving well-located properties with good tenants, some recourse, no near-term rollovers and not-too-sizable loan amounts are being made.
But the grim news is that borrowers are in for a lot of pain, regardless of whether their properties are “under water” or are solid, well-located and occupied. “Most deals will not get refinancing,” he said, adding that lenders might be amenable to loan extensions or some other accommodations for good properties (likely to be expensive for the borrowers). However, for the over-leveraged, there will need to be equity recapitalization, with lenders having to take a discount on their notes or taking back properties. Their willingness to restructure loans will depend on who the borrowers are. “It will be done on a case-by-case basis,” noted Schildkraut.
Before Fall ’08, there was enough liquidity in the system but after Lehman’s bankruptcy, he said, “the world changed.” He noted that after the beginning of the new year, borrowers seemed to understand the predicament they were in better than the lenders. Like other industry observers, Schildkraut theorized that while the lenders aren’t saying so directly, they are loath to make loans because if they have to mark their notes to market, they could be insolvent.
Ackman-Ziff is also talking about raising capital to acquire debt, but currently the “bid-ask is very wide,” so the time for that opportunity has not yet arrived.
Creativity to the Rescue?
John W. Waldeck, partner and chair of the Real Estate Group at the Cleveland-based law firm Walter & Haverfield agreed that financing is difficult on the side of ownership and development. In fact, he reported that recently clients have had two deals stopped or consigned to limbo status. “It’s difficult to get the money to flow even if lenders have made loan commitments.” He noted that checklists are being combed over more than ever in search of any rationale to halt a deal; he believes this practice is covering a larger problem, which is that lenders are concerned about lending money at all. He expects that it will take at least nine months to a year before things loosen up.
“Lenders are scared,” he said. “A one million dollar appraisal today may appraise for $800,000 six months from now and they’ll have regulatory issues to contend with.”
But here is where those parched for good news might find some relief: absent the conventional sources, owners and developers will have to find creative solutions to their financing needs. Waldeck believes that getting transactions accomplished will be reminiscent of the early ‘80s – involving seller financing. For sellers who have the flexibility and can wait out the market, a good solution might be seller financing for 18 to 36 months with an interest rate that takes risk into account.
“That’s the most common type of alternative financing that might occur,” commented Waldeck. (It is contingent on the consent of the first mortgage holder.)
One technique is a land contract, where the title doesn’t change and the first mortgage stays in place. The buyer would make payments to the seller for 18 to 36 months. Another alternative is ground leasing, which separates land from buildings; this reduces the amount of equity the buyer or developer has to raise and ameliorates the loan-to-value ratio.
Waldeck expects that going forward there will be an increase in defaults and workouts, or technical defaults with debt service coverage ratios not being met. He believes that “lenders will be less likely to pull the plug and in some cases will be willing to provide monetary support.”
Some of the firm’s clients have had loans sold to “bottom fishers,” which Waldeck characterized as flexible and not likely to pull the foreclosure trigger. “They’re looking to make money and are reasonable to deal with,” he said.
Waldeck observed that the commercial real estate industry is in the midst of its third major crisis in 30 years (the first two being the period from ’77 to ’80 and again in the early ‘90s). “If you’re an entrepreneur, is this what you have to anticipate? That once every eight to 10 years the industry will go through the ringer?” The answer clearly being yes, he advised owners and developers to “build up a substantial war chest.”
For more information
Golub & Co. www.golubandcompany.com
NorthMarq Capital www.northmarq.com
Ackman-Ziff www.ackmanziff.com
Walter & Haverfield www.walterhav.com
Upcoming NAIOP Webinar, “A Primer on Seller Financing,” April 30, 2009 www.naiop.org/webinars
By Ellen Rand, contributing editor, Development magazine
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