COVER STORY, NOVEMBER 2008

LENDING IN TODAY’S MARKET
Stalled credit markets change industry’s approach.
Jon Ross

To the general public, the purpose of the government’s $700 billion Emergency Economic Stabilization Act was murky from the start. Some angrily viewed the law as a bailout of Wall Street, and others had no idea what to think. But developers and brokers knew the real reason for so much cash. Banks had stopped lending altogether, and only a substantial influx of money could reverse this trend, reviving the commercial real estate industry.  

“A lot of people don’t understand what [the government] was trying to do,” says Tim Radomski of Atlanta-based BridgePointe Advisors. “They were trying to free up money and liquidity so the banks could start lending again. Our whole industry right now is basically shut down. It’s frozen up.”

The bailout’s effect on commercial lending won’t be know for months to come. While much of the hubbub in the press concerns the stock market, real estate developers are primarily concerned with the capital markets. Capital markets measure the availability of money — loans secured for office building acquisitions and financing obtained for new development projects. The stock market serves as a reflection citizens’ economic feelings. “If the stock market starts falling, everybody doesn’t feel good about the economy. If it starts rising, everything’s going good,” Radomski says. “In capital markets, it’s all about credit and lending and the availability of money for companies and corporations to run.”

It’s not as if the credit markets dried up over night. In the time leading up to the credit crunch, underwriting was so free that Radomski was seeing 80 percent loan-to-value rates on senior debt. Incredibly high competition between lenders led to amazing rates for developers. Nobody asked questions about the deals that were made. Everybody was happy. Then came the lending freeze, and creating liquidity in the market became a necessity.

“It’s easy for us to forget that this is a normal and foreseeable cycle. We never know exactly what creates a cycle ahead of time, but we know it’s coming,” says Chris Decoufle, senior vice president of CB Richard Ellis’ national retail investment group. “Folks that have been in business for years are saying that this is probably a little more acute than what they’ve seen in other cycles.”

One thing that’s certain to emerge from the crisis is tighter lending regulations. It will also be tougher to get a loan. But as banks became less able to lend money, new avenues for lenders have opened up. “You’re going to see some of the larger hedge funds and private investors that have a lot of money put together some debt funds,” Radomski says. “Underwriting is already ultra-conservative. It’s going to continue to be ultra-conservative until these banks start freeing up more money.”

As a result of the freeze, a large amount of commercial real estate projects have been put on hold until money starts flowing again. Anyone who doesn’t have to purchase real estate or re-finance a loan is waiting to see what happens and whether or not the bailout achieves the government’s goal. “You’re not seeing a lot of sales in the shopping center market right now because nobody knows what the cap rates are. If you do get a cap rate, you can’t get debt to buy it,” Radomski says. Long-term debt remains stable, but short-term loans that initially funded acquisitions or developments are being affected. Borrowers with well-planned developments, however, are having an easier time finding cash in the current market. When lending, companies aim for a target development, and when financing is simply not available, this target shrinks. 

“A lot of lenders don’t even have a target for borrowers to shoot for,” Decoufle says.

“The lenders that do have a target, it’s awful small.”

A few lending institutions also are seeing a relative benefit in the lack of available financing. Life insurance companies and smaller firms that couldn’t compete a few months ago have become market players. Offering low loan-to-value rates is suddenly looking much better than not borrowing money at all. “Life companies got beat out by the CMBS conduit lenders who were going 80 percent loan to value and 5 percent interest rates,” Radomski says. “Once CMBS blew up, life companies saw a huge influx of business.”

From a multifamily perspective, says Howard Smith, executive vice president and chief operating officer of GreenPark Financial, the situation was relatively stable. He’s already weathered the government’s bailout of Fannie Mae and Freddie Mac with relatively few changes in the way he does business. “The greater problem is really in the single family business,” he says, noting that his company was processing Fannie Mae loans in the first week after the government’s initial bailout. “We are still processing, we are still executing, we are still locking, closing and delivering loans.”

Taking everything into account, the government’s actions were necessary, Radomski says. Regardless of what effect the initial $700 bailout has on commercial lending, or how many successive bailouts are needed, something had to be done, he says.

“I’m a firm believer in free markets. I’m a firm believer that our government should not come in and tell the capital markets what to do or guide or regulate the capital markets, Radomski says, “but this is a bad place we’re in.”

“If the patient is the financial system,” Decoufle adds, “and the patient has massive bleeding, the first thing you’ve got to do is just stop the bleeding before you do anything. If you don’t stop the bleeding, you lose the patient.”

A CASE IN POINT: DESPITE CRUNCH, MONEY FOUND FOR CURRENT MIAMI PROJECT Met 2 Financial Center is a piece of MDM’s $1.5 billion Metropolitan Miami. Seeing a crack in the frozen financial markets, joint venture partners MDM Development Group and MetLife have secured a $250 million loan for Miami’s Met 2 Financial Center. The 3-year construction loan will ensure completion of  the project’s 750,000 square feet of Class A office space and 42-story JW Marriott Marquis hotel. Met 2 broke ground in 2007 and will deliver in the next 18 months. Borrowing money in the current economy doesn’t come without sacrifices. Mel Roth, president of International Mortgage & Equity Advisors, brought MetLife to the project 2 years ago to provide needed financial support for the building. In 2007, Roth secured two banks, Bank of America and Wachovia, for Met 2’s $354 million loan. As the credit markets started getting worse, the banks began looking for additional help. Roth watched the original two lenders become five as HSBC Bank USA, RBC Bank and Bank of Scotland got on board. “When the credit market turned upside down, [the two banks] were no longer able to underwrite and do the deal themselves, so they had to syndicate it,” he says. “To try to syndicate a loan in this credit market on a hotel and an office building was very, very difficult and complex.” The loan amount shriveled to $250 million, but construction costs stayed the same. As MetLife stepped up with the extra equity, conditions for the loan shot up. “The leasing requirement went to 40 percent preleased. When we were originally committed, those loans didn’t have any qualifications for preleasing,” Roth says. “Two, three years ago, we didn’t need to have any preleasing. Today it’s not unusual to require at least 50 percent.” Met 2 Financial Center is just one of the pieces in Miami-based MDM Development Group’s $1 billion Metropolitan Miami development. Met 1, a 447-unit condo property, has already been completed and Met 3, which includes an 1,800-space parking deck, a 45,000-square-foot Whole Foods and a 24-hour fitness center, will break ground in the second quarter of next year. Met Square, the final phase of the development, will include high-end retailers, a variety of restaurants and a movie theater. Met Square will break ground by the end of next summer.  Taking a hint from his latest deal, Roth knows that finding funding for these subsequent phases of Metropolitan Miami could be difficult. MDM has a solid development track record, but securing money in this market is no sure thing, he says. “It took the lead banks a long time to get participants lined up. It is extremely difficult to get anything done today even with quality sponsorship.” — Jon Ross

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