Development Magazine Winter 2014

Finance

Financing Unstabilized and Distressed CRE

Contrarian thinking during the economic downturn has resulted in a new, thriving company. 

Lehman Brothers, sub-prime mortgages, credit-default swaps: Just mentioning these words can dredge up unpleasant memories of the great financial crisis of 2008. What would you have done differently if you’d possessed a crystal ball before the meltdown? 

The founding partners of A10 Capital didn’t need a crystal ball. They all had one thing in common: They believed that the real estate markets in 2005-2007 were overheated and distorted. Against the prevailing wisdom of the time, they were critical of the aggressive underwriting and pricing practices of the conduits and many bank lenders. They seized upon the idea that there would be a significant correction in the real estate markets and began building infrastructure and raising capital to start a non-bank commercial real estate lender. That company, A10 Capital, was officially launched in June 2007, giving it a first-mover advantage and no legacy assets.

Building Upon Success

A10 Capital has since emerged as one of the most active lenders in the small- to mid-market bridge loan space. Anchored by large investments from the $15 billion global private equity firm H.I.G. Capital and a Fortune 500 insurance company, A10 Capital has developed a scalable funding model that enables its loans to remain on balance sheet and to be serviced in-house. A10 primarily focuses on financing unstabilized and distressed commercial properties on a nonrecourse basis. However, the firm also finances fully stabilized properties when the owner/borrower plans to sell the property and wants to avoid the prepayment penalties and inflexibility of a permanent mortgage. 

headshot of Jerry Dunn

Jerry Dunn

Loans range from $1 million to $20 million and typically come with a future funding mechanism for capital expenditures, tenant improvements and leasing commissions. Loan terms are up to five years to provide sufficient time for borrowers to execute their business plans. Property types include office, retail, industrial, multifamily and self-storage, and are typically Class A and B properties located in the nation’s top 150 metropolitan statistical areas. Borrowers range from multi-billion dollar institutional investors to savvy local operators who raise their equity from friends and family.

Current Themes

For the past few years, A10 has enjoyed significant year-over-year growth in its loan portfolio, and 2014 is shaping up to be no different. The firm has seen high-quality properties acquired at significant discounts to their pre-crisis levels. It recently closed a $14 million loan to finance the purchase of an 888,000-square-foot Class A bulk distribution facility located in a primary market in Texas. The property previously had a $30 million commercial mortgage-backed securities (CMBS) loan that went into default after the sole tenant went bankrupt. A10’s borrower acquired the building for $18 million from a CMBS special servicer with a plan to re-lease the property to multiple tenants. Prior to closing, the borrower signed a 262,000-square-foot lease with an investment grade tenant that created significant upside for the property on day one. The tenant, a global logistics company, likely will act as an anchor to attract additional tenants. Based on A10’s current pipeline, the company sees no shortage of solid properties like this that are being sold at a compelling basis via traditional brokerage and auction platforms.

For the past few years, everyone has been hearing about the $1.4 trillion looming commercial mortgage maturity cliff. Yet A10 did not experience much in the way of loan requests to refinance maturating loans until the second quarter of 2014. In just the first few weeks of August, the firm refinanced three maturing CMBS loans. All three were for high-quality office buildings located in larger markets, and all three buildings had suffered recent vacancies that left them unable to refinance with another permanent loan. All three borrowers looked to A10 Capital to provide a “stretch LTV,” a higher-leverage senior loan to minimize or eliminate the amount of fresh equity the borrower had to bring to the table to refinance. In one case, to refinance a $14 million CMBS loan that had already matured, the capital stack had to be completely reworked because the property was only 29 percent occupied after two major tenants vacated. A10 ended up structuring a $7.2 million senior bridge loan and a $2.2 million mezzanine loan. One of the reasons A10 was able get creative is because the borrower made a major recommitment to the property by bringing in over $4 million of fresh equity to complete the refinancing. A10 is hearing that the largest CMBS special servicers are gearing up for these upcoming maturities, and thus expects even more scenarios like this to play out in the coming years. 

From the Archives: Finance Articles from the Previous Issue

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Crowdfunding Scales Up 

This being baseball season, a baseball metaphor seems apt to describe the stunning year-long rise of real estate crowdfunding: dramatic growth aside, we are still in the bottom half of the first inning. Crowdfunding is much like old-style syndication, but with the turbo engine of the Internet behind it.

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The Impact of Interest Rates on Cap Rates 

What’s the outlook for the economy and for interest rates for the rest of the year? Steady as she goes, as long as the Federal Reserve makes no sudden drastic changes to its monetary policy. Rates are likely to rise moderately over the next 18 months to two years, with steadily improving employment and a gradual pickup in inflation. That’s how JLL sees it, as the company recounted earlier this year in its “Interest Rate and Cap Rate Perspective” report.