How Financing Looks Now

Spring 2010

If there’s a good deal, there’s no liquidity problem. If you own real estate that’s overleveraged, there’s no financing. If you have a well-leased property but it’s underwater, "you’re probably screwed."

That summary was offered by Jeff Friedman, co-founder and co-CEO of Los Angeles-based Mesa West Capital. The firm provides first mortgage and moderate level bridge loans in the $10 million to $75 million range, mostly in Western markets but also in gateway cities outside the West. Loans are priced a bit above insurance companies, with no recourse. Mesa West also lends more or will finance developments that are not stabilized. It has a $1.5 billion lending capacity.

Jeff Friedman

Jeff Friedman

On the equity side, Friedman said, there is "a ton of capital on the sidelines. An asset bubble exists and will grow. Already, you’ll have 15 to 20 offers on quality assets; they’re bid up beyond what’s supportable, if it fits in a ‘box,’ though pricing is 40 percent lower than it was three years ago."

Friedman reported that the financing winds shifted after Labor Day 2009, with a pick-up in deal flow (that had been moribund until that point in 2009), for deals that made sense. "Investment sales activity picked up from virtual paralysis," he said. Mesa has seen a pickup in discounted loan purchases, at around 60 cents on the dollar, since the last part of 2009 and expects that to continue this year. Friedman does not expect to see a "tidal wave" of deals this year, however, despite all the debt coming due in the next few years.

Friedman noted that the supply of debt capital is still constrained. Life insurance companies are lending again but their requirements are rigorous and unless a property fits neatly into a "box" of qualifications, borrowers are out of luck. They are looking more closely at the quality of the sponsor, product, tenants, preferring no near-term lease rollovers and low leverage. Commercial banks are back in the market, too, but there has not been "a flood of activity," he said, adding that banks seem to be addressing problem loan portfolios more than they had in 2009. "They’re saying, ‘we can foreclose or you can buy the loan back from me,’" he remarked. "They won’t be in the zombie state that financial institutions have been in."

Friedman noted that while office fundamentals will deteriorate over the next couple of years, that is being priced in when there are investment sales. Mesa likes higher quality office as well as hospitality, where he said "the reset has already been hit." Regarding industrial property, Friedman said, "we love it, generally. We’re willing to tolerate a lease-up situation, a 50 percent occupied property, if there’s a good basis."

The firm is more skittish about retail and doesn’t feel like retail has been hit yet. "There’s a 20 percent oversupply in retail, though there are exceptions. It’s harder to understand how the reset works."

‘Early is the New Wrong’

Based on respondents’ predictions cited in the Emerging Trends in Real Estate® 2010 report, released by PricewaterhouseCoopers LLP and the Urban Land Institute (ULI), the best investor bets for 2010 include:

  • Deal with cash — Cash is the only way to operate and only the most liquid can take advantage of the emerging opportunities.
  • Patience will be rewarded — Early is the new wrong as the economic uncertainty will hamper the recovery and absence of ready refinancing in comatose debt markets adds more risks.
  • Focus on quality and be selective — Seek irreplaceable Class A properties with debt maturity in places like New York, San Francisco and Washington, D.C.
  • Stick to global pathways — where recovery will happen more quickly.
  • Buy cash flow and real yield — Anticipate creating value by filling vacancy and increasing rents over time.
  • Provide financing Three- to five-year loans can deliver low teen returns.
  • Implement asset management triage — Focus capital and resources on retaining and attracting tenants in properties with better long-term value.