At the risk of inducing mortgage envy, here is a story of how financing – even construction financing for a speculative building – can go very, very right. Of course, it helps to have a Class A property in a top tier market. Even so, challenges had to be overcome at a time of flux and uncertainty in the capital markets.
CBRE Capital Markets arranged $181 million in financing for the first two phases of Sentinel Square, a multi-phased, 1.3 million-square-foot office development located in the heart of the NoMa (north of Massachusetts Avenue) submarket of Washington, D.C., on behalf of the Trammell Crow Co., Crow Holdings Capital Partners LLC and Cottonwood Partners. (Trammell Crow is an independently operated subsidiary of CBRE Group, Inc.)
How did this come about? The construction loan on 90 K Street, the first phase of Sentinel Square, which had been arranged in 2008, was to come due in December 2011. A 12-story Class A office building, 90 K Street opened 85 percent leased in June 2010 in spite of difficult market conditions. Its tenants include the U.S. Department of Veterans Affairs, the U.S. Parole Commission, Customs and Border Protection and the U.S. Department of Homeland Security.
The second phase of Sentinel Square is 1050 First Street. Now under construction, it will be a nearly 279,000-square-foot Class A office building which, like 90 K Street, will be a high security, environmentally sensitive property and is expected to attract both the Federal government and the private sector.
According to Tom Finan, managing director of Trammell Crow, in the second half of 2011, the partners analyzed their options in light of 90 K Street’s maturing loan: Should they sell? Should they refinance? They decided to pursue refinancing. The partners held another three parcels of land on the site and believed that even if the capital markets continued to be challenging, they had something unique and the market had improved sufficiently. Moreover, they reasoned, if they could deliver this building sooner than others, as they had done previously, they could succeed. The conundrum was this: financial sources that are attracted to stabilized assets and those that are attracted to construction financing are two distinct groups, Finan explained: How to marry the two?
Joe Donato, executive vice president of CBRE Capital Markets, explained that the search for financing for 90 K Street included insurance companies, domestic and foreign banks, and domestic and foreign banks for 1050 First Street. “Various lenders were interested in 90 K and there were multiple offers from banks and insurance companies to cross collateralize, but that was not the goal for the borrowers,” he said. Domestic banks wanted some form of recourse, too, ranging from 25 to 50 percent.
The solution was to arrange two loans: one to refinance 90 K Street and the second to fund the construction of 1050 First Street, on a non-recourse basis. Financing was provided by Landesbank Hessen-Thüringen Girozentrale and Norddeutsche Landesbank Girozentrale. A $111 million loan on 90K Street funded the repayment of the existing construction loan while also monetizing the value that the borrower created through the lease-up of the property. A $70 million loan provided the necessary funding for the borrower to develop 1050 First Street on a speculative basis.
David Neuman, principal of Trammell Crow, estimated that the rate is under four percent. Financing is fixed-rate for 90 K Street, while the construction loan for 1050 First Street is floating, with a cap. Terms are for five years.
Donato praised the lenders because “They are real estate minds, very receptive, more than willing to find a solution that works for both lender and borrower.” And it was arranged fairly quickly: the search for financing began around Labor Day 2011; the first loan closed by Christmas, while the second closed in February of this year.
David Neuman said that the financing “pulled something off that domestic banks were afraid to do.”
“This financing provided a flexible structure allowing the borrower to monetize the value created through the successful development and lease-up of 90 K Street and begin development of 1050 First Street on a speculative basis,” said Donato.
This was not Landesbank Hessen-Thüringen Girozentrale’s first foray into the Washington, D.C. market. Three years ago, it provided $100.5 million in financing for JBG Companies and Rockwood Capital LLC’s 1101 K Street NW. Donato said that the German banks understood Trammell Crow’s track record (especially its success in working with the GSA), the quality of the buildings, the surety of closing and the “impressive growth” of the NoMa submarket, whose Class A office vacancy rate stood at 9.2 percent at the end of 2011. They also understood there’s speculative, and then there’s speculative in Washington, D.C. That is, the GSA does not pre-lease space; the demand for space — particularly for environmentally friendly and highly secure space — from the Federal government, however, continues to be strong.
“The lenders were able to put the story together,” Donato said.
The two-loan structure enables some of the excess cash flow from 90 K Street to be used as additional collateral on 1050 First Street during its lease-up period, without jeopardizing the equity in 90 K Street, he explained.
Tom Finan said, “We believe that the size of the demand from the Federal government is still massive. Even when they tighten their belts that will still be true and there’s a lack of new supply.” He expects that 1050 First Street will capture rates “significantly higher than 90 K Street.”
After 1050, the developer still has another 600,000 square feet to build out, and will be “mindful of the market,” Finan said. But while Trammell Crow is looking at other opportunities elsewhere in this market, he expects that this will be a “fairly dormant year,” and that activity will be on a deal-by-deal basis.
Neuman said that having good representation in the capital markets, creating competition and opening relationships that it didn’t have, as well as managing the process, were key strengths of CBRE Capital Markets.
Does this financing mean that foreign banks will become more of a factor in the mortgage market? Not necessarily. Donato said that the absolute number of foreign lenders is lower than it had been, but that those lenders want to limit themselves to the top four or five markets in the United States. They are seeking “the best deals in the best markets and for those, they’re going to be aggressive,” he noted.
As for domestic sources, Donato observed, “The capital markets are always evolving. Lenders are in and out, depending on what’s going on in Europe; there’s noise with the Federal government, there’s a certain level of instability. As a result, you’re never quite sure who the lender is going to be.”
“Construction financing these days is generally limited, except for multi-family. In the meantime, most life insurance companies have had their financing allocations increased but will have a hard time finding properties. But there is plenty of capital for quality properties,” commented Donato.
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CBRE Capital Markets
Trammell Crow Company