Despite the rainy weather, the mood was upbeat at the 2019 IMN Winter Forum on Real Estate Opportunity and Private Fund Investing, held at the Montage Hotel in Laguna Beach, California. Over 1,100 people registered for the event, which according to IMN’s website is:

 “Developed by leaders within the commercial real estate (CRE) industry representing the full spectrum of industry participants including funds, developers, LPs, law firms, accounting firms, technology firms and other service providers to the industry, the agenda offers real estate investors a strategic approach to the current regulatory and investment environment.”

Tower Capital had a strong presence at the conference and was represented by its Principal, Kyle McDonough, and Vice-President, George Maravilla. In accordance with the last several years, multifamily remains a favorite asset class among private equity investors while retail is still avoided by many. Despite an overall bullish market outlook, investors are being selective – looking for quality projects, in strong locations, with experienced sponsors - and underwriting remains uncompromised. However, when a project does check all the boxes, some equity investors are willing to stretch a little more than in the recent past by allowing the sponsors to contribute a smaller equity percentage of the total capital stack, and thereby have less “skin in the game.” In recent years, a sponsor (or syndicator) would be required to write a check for at least 10% of the total equity required for the project from their own funds. Under current conditions some investors simply want to see an amount “that is meaningful to the sponsor.” This is because of the ever-increasing amount of capital sitting in funds waiting to be deployed.

Given where we are in the current market cycle, some funds are de-risking by offering mezzanine financing where their position is more secure than straight equity. These capital providers may lend up to 90% of the total capital stack for the project, with pricing as low as 12%. Return expectations have simmered to an extent, with investors accepting returns in the low to mid-teens for existing value-add projects and high-teens to low 20’s for ground up development.

Several funds have been created targeting opportunity zone projects, which have been created to help direct resources to traditionally low-income communities, known as Qualified Opportunity Zones, through a more market-driven approach. Projects situated in these newly designated Opportunity Zones offer a number of financial incentives to long term investors.

If you have are seeking equity financing for a project, or would like to learn more about different equity programs being offered in today’s marketplace, please contact Kyle McDonough or George Maravilla, at Tower Capital.

Keep in mind, this has not been finalized as it is currently going through legislation.

With the S&P 500 continuing to set record highs, opportunity zones represent an excellent way for taxpayers to realize their gains and diversify their portfolio away from the equities market while deferring and mitigating some of their capital gains taxes. It can also be a way to make low-income housing pencil for developers in an environment of rising construction costs.

The Investment in Opportunity Act was included in the 2017 Tax Cuts and Jobs Act. Taxpayers can defer and potentially reduce capital gains by making timely investments in opportunity zone properties. The purpose is to incentivize and foster investment in low-income communities, or LICs, to jobs and accelerate the growth of small business formation.

Opportunity Zones are found in census tracts that are classified as LICs. These same LICs are based upon poverty rate (20%) or median family income (80% of national average). There are 74,000 census tracts in the United States and slightly more than a third are considered LICs. The LIC must then be nominated by the Governor and 168 in Arizona are eligible for nomination.

 

3 Potential Tax Incentive Benefits

 

1. Temporary Deferral of Capital Gains Taxes

The amount of deferred gain subject to income tax is based on the lesser of the amount of the deferred gain or the fair market value of investment in the Opportunity Fund less the taxpayer’s basis in the opportunity fund.

 

2. Partial Reduction of Deferred Gain

The taxpayer has an initial basis in the opportunity fund of zero. 

• Hold for 5-years: Investor’s tax basis in the opportunity fund is increased by 10% of the amount of the deferred gain.
• Hold for 7-years: Investor’s tax basis in the opportunity fund is increased by an additional 5% of the amount of the deferred gain.

 

3. Forgiveness of Additional Gain

If held for 10 years, then there is no taxable gain on the appreciation of the asset.

 

To see if one of your properties could be in an opportunity zone, check out this interactive map from the Community Development Financial Institutions (CDFI) Fund. If you have additional questions about how investing in commercial real estate located in an opportunity zone could help your portfolio, please reach out to Tower Capital today.

 

Tower Capital, a commercial real estate structured finance firm, announced that George Maravilla has joined the firm’s Phoenix office as Vice President. In his new position, Mr. Maravilla will be utilizing his extensive 14-year background at DMB Associates, a Scottsdale-based developer specializing in master-planned communities, country clubs, mixed-use commercial, multifamily, office and retail developments throughout the Western US and Hawaii.

Mr. Maravilla recently served DMB as Director of Finance where he was responsible for managing project level financial risk and establishing the appropriate development strategy. He also created long-term capital plans, project life cycle capitalization, deal structuring, and was in charge of project investor/partner reporting. Furthermore, he evaluated new opportunities in a wide range of residential and commercial asset classes having underwritten more than $700M in potential acquisitions and vertical developments during his time at DMB.

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January 17-19^th, 2018

The weather was beautiful at the Montage resort in Laguna Beach this year for the 15^th Annual IMN Real Estate Opportunity & Private Fund Forum, the premier conference for commercial real estate focused private equity in the country. The vibes and energy were positive and bullish. With over 1,000 registrants for the three-day event, participants exchanged critical market information, strategic insights, and the unmatched networking opportunities were a breeding ground for deal-making.

While hesitation and uncertainty over the new Trump administration led to a bit rocky and slower start to 2017, this new year began with a bang as optimism over the recently passed tax reform bill, and continued historically low interest rates, are providing additional oxygen for a hot commercial real estate market.

A MAJOR THEME PERMEATING THE CONFERENCE:

There are more non-bank lenders becoming increasingly active in the debt space as capital flows in to fill the gaps left by banks (caused by increased banking regulations stemming from the 2008 recession). For lower leverage, higher quality transactions, floating rate life company debt is now available at very tight spreads and pricing. Opportunity debt funds and some private equity groups can offer higher leverage “stretch senior” loans or mezzanine financing. It remains a borrower’s market.

Some of the equity groups showed some concern that we may be in the last innings of a cycle and are cautious about sponsors’ exit cap projections in an environment of increasing interest rates. They are typically looking for opportunistic or value-add deals which will provide high teens IRR’s with 1.75+ return multiples. While most bridge loans are 12-36 months in length, the equity has slightly longer time horizons, generally in the two to seven-year range.

The favorite asset class among the majority of participants remains multifamily, with industrial seemingly coming in second, followed by a bullishness over urban office. The fundamental shifts in spending habits by consumers continues to cause upheaval in the retail sector, where many investors are still shying away from.

What Are the Risks?

1. Rising interest rates could finally create enough headwinds to cause a pause and begin to push valuations lower due to eventual rise in cap rates. This affect would probably not be seen this year, but may show signs of life in 2019 following some lag time.
2. Tax reform does not provide the economic stimulus that the markets anticipate.
3. Competitive lending environment forces non-bank lenders up the capital stack, increasing the risk profile, as they work to push money out the door, leaving many hanging when the music stops.

Predictions:

1. Frothiness in market to continue.
2. Increased development across most asset classes, with office and industrial benefitting from increased earnings and expansion encouraged by tax reform.
3. Look for more non-bank lenders adding fresh liquidity to the debt markets such as life companies, CMBS, and opportunity funds.

There appears to be a sort of unfortunate urban myth that public transportation projects makes nearby neighborhoods less desirable. Certainly, the construction phases of some projects may generate noise and cause some inconvenience. No research supports the idea that public transportation increases crime or negatively impacts property values.

The Positive Impact of Public Transportation on Property Values

In fact, plenty of research supports that intuitive notion that easy access to public transportation makes local properties even more desirable. Not only do people favor it and understand the benefits, increased transportation has already demonstrated its ability to increase property values.

Americans Increasingly Favor Public Transportation

Naturally, the American Public Transportation Association works hard to promote the virtues of light rail, subways, busses, and other modes of public transportation. They certainly make the case that Americans are increasingly drawn towards using shared transportation over their own personal vehicles:

• In the past two decades, the use of public transportation has increased by about one-third. This is a greater increase than the overall population and the number of vehicle miles driven.
• A study of almost 500 urban areas found that sharing transport saved 450 million fuel gallons and 865 million travel-time hours within one year.
• A dollar invested in public transport yielded about four dollars in economic returns because of cheaper commuting options, transportation employment, and other factors.

Recently, the Millennial Generation took over from Baby Boomers as the largest population of the workforce. A study from the Rockefeller Foundation found that almost two out of three of these younger workers considered access to public transportation one of the main factors they would use to decide where to live. More than half of the survey respondents even said they would strongly consider moving to another city if the only deciding factor was better access to city transportation.

Public Transportation Doesn't Increase Crime

The National Association of Realtors explored the idea that public transportation had an impact on crime rates. As an example, they cited a study of Los Angeles from the University of California. The study found that neighborhoods and streets around Metro stations did not have higher levels of crime than other locations within the metro area.

In fact, the study concluded that these neighborhoods often had lower rates of serious crimes because more police and security guards tended to have been deployed nearby. The University of California study did report that the natures of crimes might change. For instance, pickpockets might be more common around transit stations, but car thieves were more likely to work around parking lots.

Additional Public Transportation Improves Property Value

It's easy to prove that public transportation offers benefits like more affordable commuting, less traffic congestion, and of course, reduced energy use and greenhouse gas emissions. Similarly, it's not difficult to debunk the myth that public transportation encourages illegal activities and to support the idea that it improves economies.

Public transportation typically benefits people and the environment, but how does it impact property values? Consider some studies of very different kinds of areas:

• High-value properties: First, it might be helpful to consider San Diego, an area with famously high property values in the first place. The Urban Land Institute found that all kinds of property that were closer to the transit system enjoyed a premium of 17 percent over comparable properties that were further away. In other words, accessible transit options can even increase the value of high-value properties.
• Economic downturn areas: In Chicago, single-family home prices in suburban areas dropped by almost 20 percent during the Great Recession. Suburbs that had service from the city's transportation system only saw a decline of 15 percent. Public transportation can preserve value even when the economy is driving property values down dramatically.
• Typical metro areas: Dallas, Texas is an example of a city with all sorts of types of properties. Typically, people think of Dallas a place with a deeply embedded car culture too. A University of North Texas study found  that properties near the DART lines increased by 39 percent over properties that were not served.

Are Property Values Always Improved by Public Transit?

Of course, it's possible to find some examples of people who did not enjoy an increase in property values because they were near a transit station. You might visualize a movie trope where a poor person has to endure rattling windows in their apartment when the nearby train roars past. Old-fashioned trains, poor planning, and other factors may sometimes make properties that are right on top of a public transportation station less desirable. However, it's fair to question if the positives in even these situations wouldn't outweigh the negative of lacking access to affordable transit.

It's fairly safe to say that public transportation almost always improves the value of business properties, single-family homes, and multi-tenant buildings. Besides the obvious benefit of having an alternative to using a car every day, public transit can reduce congestion for people who do use cars, conserve fuel, lower emissions, and improve the economy.

Source:

http://www.apta.com/mediacenter/ptbenefits/Pages/default.aspx

https://www.houselogic.com/save-money-add-value/save-on-utilities/public-transportation-adds-value-home/

 

Multifamily borrowers are continuing to benefit from a strong rental market. Many are taking advantage of the increased rents and NOI’s by refinancing and pulling cash out to be used for a variety of purposes, such as returning equity back to investors, performing capital improvements, or applying the funds toward additional investment opportunities.

• Banks and credit unions will typically lend up to 70 – 75% LTV on stabilized assets.
• They are typically looking for 24 – 36 months of seasoning shown through a leveling of revenues and expenses on the operating statements, prior to allowing a full cash out of all the borrower’s equity on value-add deals.
• If the borrower has owned the property for less than 18 – 24 months, the lenders will typically offer loan proceeds based upon the borrower’s total cost, and not on the current perceived value of the property.
• Fannie Mae and Freddie Mac remain the most competitive non-recourse multifamily lenders for investors looking for longer term, fixed rate, loans at higher leverage.
• Life Co's most competitive at lower leverage with some offering full term IO, forward rate lock, or more unique structures.
• The agencies will lend up to 75 – 80% LTV after 18 months of ownership, and can provide supplemental financing after 1 year of placing the initial loan.
• While short term borrowers have seen coupon rates rise due to increasing 30-day LIBOR, decreasing lender spreads have helped buffer the increase.
• Treasury rates remain steady and long term borrowers can still obtain 10 year money in the high 3 to low 4% range depending on loan size, asset quality, and location.

With the capital markets being so competitive in today’s finance environment, the highest degree of value a mortgage broker or banker can offer their client is surety of execution. Any experienced investor or intermediary knows that there are a number of issues that can arise to make a deal go sideways. Fortunately, solutions can be discovered and time, energy and money saved, by asking a few questions from the start - to both the borrower and the lender.

There are a number of basic, but very important, questions that should be asked by one’s mortgage broker during their initial conversation with their client in order to evaluate the requirement and ascertain the best capital source to meet the borrower’s investment goals and objectives. Borrowers should be weary if their intermediary is not asking the necessary questions up front since lack of information could lead to some very unwelcome surprises down the road.

1. What is the ownership structure and who comprises the borrowing entity?
Having an understanding of the ownership structure is of paramount importance because it is a lead-time item that will often dictate much of the lender due diligence items to follow. An organizational chart is the most effective way to illustrate the ownership structure and shows the ownership percentages of all key principals and sub-entities. Typically, the lender will want financials on any person or sub-entity that owns greater than 20% of the borrowing entity. Many times this can be side-stepped if whoever is signing the loan has a balance sheet strong enough to meet the lender’s minimum net worth and liquidity requirements, either on their own or in combination with the other sponsors in the deal. This leads us to our next question…

2. What is the net worth and liquidity of the sponsorship?
Whether it’s a recourse or non-recourse loan, acquisition, refinance, or new development, the sponsor signing the loan must meet minimum net worth and liquidity requirements set forth by the lender. These minimum requirements will vary by lender and transaction specifics, and can usually be met by one sponsor or a combination of whoever is signing on the loan documents. Lenders typically want to see a net worth equal to or greater than the loan amount and liquidity (cash, stocks, bonds, marketable securities) of at least 10% of the loan amount AFTER the down payment has been made. Construction lenders will often have higher liquidity requirements due to the likelihood of cost overruns that can arise during the construction process.

3. Is the borrower willing to sign personal recourse on the loan?
Many borrowers prefer not to provide personal guarantees if they don’t have to. However, despite the seemingly abundance of non-recourse debt available today, however this preference may limit the lender pool or amount of loan dollars the lender is willing to provide on a specific transaction. The most common source of non-recourse financing is CMBS, HUD, Fannie Mae, Freddie Mac, and debt funds. Banks, credit unions, and life insurance companies can also offer non-recourse financing but typically at lower leverage – anywhere from 50% to 65% loan-to-value.

4. What is the borrower’s investment time horizon for the asset?
With interest rates currently at all-time lows, many borrowers are opting to lock in long term fixed rates. If you are a long term investor then this may be the best strategy for you, however, if this is a shorter term investment, such as a value-add reposition, or if you want to leave the option open to sell in the future, then locking in long term fixed rate debt might not be the best solution since it usually comes with stiffer prepayment penalties and may not be assumable by a future buyer. I discuss this more at length in my previous blog titled: The Trap of Low Interest Rates: Ensuring Financing is in Line with an Investor’s Goals & Objectives, which I encourage you to read.

5. What are the Borrower’s hot buttons?
This question might seem like the most obvious but many mortgage brokers do not ask because they think they know the answer through conversation with the borrower. This may be true, however, the answer is not always evident. That is why I very directly ask, “So what is most important to you? What are your hot buttons?” Is it the lowest interest rate? Highest amount of loan dollars? Prepayment flexibility? Term length? Non-recourse? Speed? Or perhaps it is a combination of these or none of these.

The next set of questions relate to the lenders. If a mortgage broker or borrower has not worked with a particular lender in the past then these questions are crucial to ensuring a smooth and successful financing process.

1. What is the lender’s approval process?
Having an understanding of the lender’s process is critical. Quite often lenders will issue loan quotes or term sheets that aren’t worth the paper they are written on. This can set the borrower up for what we in the industry commonly refer to as a re-trade (a reduction in loan dollars) down the road, or worse yet, a flat out denial of the loan altogether, leading to a lot of time, energy and money wasted. When an LOI or term sheet has been issued, has it been pre-vetted by credit or simply underwritten quickly by the banker or originator? At what point is a formal commitment or approval provided? Does this happen before third party reports are obtained or afterwards? How many people are involved in approving the loan? The more signatures required, the greater the possibility that one of the decision makers will not like something about the deal and reject it. I always ask if someone involved in the decision making process has seen the deal before terms are issued. Sometimes the loan committee is simply providing a rubber stamp by the time they see it, and sometimes they are being presented with all of the information for the first time.

2. How is the lender underwriting the transaction?
Knowing how the lender underwrites allows the mortgage broker to quickly vet which lenders will be viable options up front. Lenders will often increase historical expenses by some percentage, such as 3%, or may adjust expenses (either up or down) based upon industry standards when they underwrite and calculate Net Operating Income. They may also use a higher interest rate than the note or coupon rate being offered or utilize increased debt service coverage ratios for stress test purposes. The results can often negatively impact the amount of loan dollars offered.

3. What 3rd party reports does the lender require?
The most prevalent report for the vast majority of commercial real estate loans is the appraisal. Appraisals can be short or long form and are tailored to each lender’s particular parameters and requirements. A standard commercial appraisal will typically take 2 – 4 weeks to complete and can cost as little as a couple of thousand dollars or over $10,000 depending on the complexity of the transaction. Appraisers can provide “as is” values or “as stabilized / as complete” values if there is a renovation or stabilization component. The second most prevalent report is a Property Condition Report (PCR) provided by a structural engineer. The findings contained in a PCR can lead the lender to hold back loan dollars for repairs to the property which may or may not be in the borrower’s existing budget. This may cause the borrower to have to procure additional equity to close the transaction and may present a problem if those funds are unobtainable. A Phase I Environmental Report may be required, especially if the property is located near a gas station, laundry mat, waste disposal facility, or if a prior use of the property leads the lender to believe that there is a possibility of contamination at the site. Finally an ALTA Survey may be required by the lender or Title Company in order to provide proper title insurance.

4. What are the fees associated with the loan?
Typical fees include: origination, processing, underwriting, administrative, credit check, legal and application fees. All of these fees can add up quickly, especially lender legal. Sometimes lender legal and 3rd party costs are covered by the application fee but sometimes these costs are additional. Lender legal fees can be the biggest variable and it should always be known if this cost will be passed through to the borrower and what they typically run on an average transaction. Lender legal bills offer borrowers the most exposure to expenses that are completely out of their control and can add up to hundreds of thousands of dollars.

In conclusion, surety of execution for any commercial real estate loan can be increased drastically by asking the right questions at the beginning of the process to both the borrower, as well as the lender. By following the suggestions above, a lot of future pain can be avoided.

Written by: Adam S. Finkel, CCIM, Tower Capital

IRC Section 1031, also known as a 1031 exchange or a “like-kind” exchange, allows investors to defer tax on gains from the sale of an investment property if they reinvest the proceeds into a similar (like-kind) property. It was enacted by congress in 1921 to promote economic growth by encouraging reinvestment into the economy and to avoid harming investors through unfair taxation as they reinvest.

Although many associate this rule as a tactic used in commercial real estate, there are many other types of investments to which the rule can apply including: livestock, oil, gas, and mineral interests, gold, silver, and numismatic coins, water and ditch rights, and collectables such as antiques, cars, stamps, and gems. Those things not eligible include a primary residence, indebtedness, stocks, bonds, or notes, partnership interests, and inventory.

Five Important General Rules:

1. Use of Intermediary
   The simplest form of exchange is when a buyer and seller swap properties simultaneously between each other. However, the vast majority of 1031 exchanges are known as delayed, three party, or Starker exchanges. In this type of exchange, an intermediary is needed to hold the cash from the sale of the first property until the investor identifies the new property and then the cash is used to close on the replacement.
2. Same Taxpayer
   The tax return and name appearing on the title of the property that is sold must be the tax return and titleholder that purchases the replacement property. For example, if the first property is owned by the entity “ABC Partnership,” which is comprised of six total equity partners, then the titleholder for the replacement property must also be “ABC Partnership” comprised of the same six equity partners.
3. Like-Kind
   Although we typically associate 1031 exchanges with commercial real estate, there are many other types of investments that can qualify. The “like-kind” terminology simply refers to swapping one type of investment with another (i.e. real estate with real estate or antique with antique). Fortunately for real estate investors, real estate covers a broad spectrum of assets so for instance, an investor could sell an apartment building and trade into a retail center, office building, another apartment project, or even land.
4. Timing
   There are two time constraints to take into consideration when consummating a 1031 exchange. The first is that the investor has 45 days from the time the sale of their property closes to identify a new property to purchase. The second is that the investor must complete the purchase of their new asset no later than 180 following the close of their original asset. Please note that the total time frame to complete the 1031 exchange is 180 days, and not 45 days plus 180 days.
5. Property Identification
   Within the first 45 days following the sale of the relinquished property, the investor can identify up to three replacement properties, regardless of value. These properties must be identified in writing by either a property address, legal description, or distinguishable name of the project. The investor must close on one of the three identified properties to qualify for the exchange.

Exchanger Beware! Three Points to Consider

There are few points to be aware of before entering into a 1031 exchange.

1. Although taking advantage of this tax strategy can create savings for the investor, they must be careful not to overpay for the replacement property, especially in a tight market. Resulting future losses from overpaying could offset any current savings on taxes.
2. In order to avoid paying taxes on the proceeds from a sale, the investor must make sure they are trading up: purchasing a replacement property that is at a higher value or cost basis than the relinquished property. Any leftover cash, or “boot,” from the sale will be taxed, typically as a capital gain.
3. Make sure to use a qualified intermediary. There have been instances of exchange facilitators filing bankruptcy or being unable to meet their contractual obligations to their client. This can result in the investor not being able to meet the strict timelines set forth by the tax code, thereby disqualifying them from completing the 1031 exchange.

1031 Exchanges Explained
Written by Adam S. Finkel, CCIM
Tower Capital
Phoenix Arizona

The afternoon sessions focused largely on the state of the economy and the drivers affecting it.

The opening RealShare National Investment & Finance Conference session was titled Power Panel: Direct from the C-Suite and was moderated by Lew Horne, President of CBRE Greater LA/Orange County Region. Panelists included Warren De Haan, Founder & Managing Partner of ACORE Capital; Ken Perry, President & CEO of The Swig Company; Fred Schmidt, President & COO at Coldwell Banker Commercial; Lydia Tan, SVP at Bentall Kennedy; and Thomas Whitesell, Managing Director at Capital Source.

Despite the geopolitical issues facing Europe, the Middle East, and Africa, the global markets have been strengthening overall. There was a 40% increase in investment activity from 2013 to 2014, with America responsible for about half the volume last year at $545 billion. The top 6 markets were London, Tokyo, San Francisco, Sydney, New York, and Dallas. The commercial real estate market in the US is benefitting largely from employment drivers in energy, education, medicine and technology.

Overall, most asset classes have seen gradual decreases in vacancy, however, each sector faces its own challenges. All time high stock market prices have helped the wealthy to become wealthier and at the same time the country’s poor are provided with greater subsidies, which puts additional squeeze on the middle class and is illustrated through consumer shopping habits. Both high-end retailers as well as discount brands have seen revenues pick up, while those catering to the middle classes struggle. The shift from brick and mortar to online shopping by consumers is a dynamic continuing to affect the retail industry, causing less demand for traditional retail space. Retailers are shifting their focus towards supply chain and how to best accomplish same day fulfilment to their customers. Consequently, the industrial sector has benefitted from increased demand for warehouse and fulfilment centers. The office sector is facing challenges of its own. While it seems that a strengthening economy has ushered in new job growth, the average square foot per employee has decreased to 175 square feet, which has minimized space absorption to some extent. In multifamily, millennials will continue to be a driving force for the next 20 years as developers and property owners cater to their specific tastes, which include smaller unit sizes but with nicer finishes and a greater number of property amenities.

Overall across all sectors the debt markets seem to be driving valuations. Lenders are dropping their minimum debt yield requirements to win deals, which lead to additional loan proceeds and higher prices. The debt markets are providing investors with strong risk adjusted returns in comparison to other alternatives, such as the bond market. With capital readily available and looking to be deployed, the frothiness experienced in today’s capital markets environment should continue for the foreseeable future. There was a consensus that some slowdown in capital might be healthy. The only reason why some deals are making sense for investors is because capital is so cheap and this causes inflated pricing. The last downturn was due in part to a lack of discipline by investors and there is a concern that the same mistakes are already being repeated.

The last panel of the day was In Search of Yield: The Outlook for Investment. The moderator was Michael Zietsman, Managing Director at JLL and the panel featured Geoff Davis, President of HREC Investment Advisors; Paul Feinstein, Managing Director of Wealth Management at UBS, Christopher Flick, SVP at PIMCO; and Lynn King-Tolliver, SVP at Heitman Capital Management.

Lynn King-Tolliver started the discussion by noting that the market overall is showing a healthy construction pipeline that seems to be in line with demand. She believes that the market has another 24 -36 months of growth before there is an adjustment, however it is uncertain what the trigger will be. Christopher Flick of PIMCO shared the sentiment that there is room to grow but is worried about the market’s reaction to an increase in interest rates. The panel showed some agreement that when the next downturn does arrive, it will not be as long or as deep as what was experienced during the Great Recession. It was difficult to form a consensus on exactly where we are in the current cycle but one thing was certain – the USA is well ahead of Europe.

It is no secret that US-based institutions have been facing tremendous competition from foreign investors looking for a safe haven to plant their money, contributing to cap rate compression and increased property values. However, unlike in the past, foreign capital is not just sticking to gateway markets. They too are beginning to chase yield in secondary markets. Foreign investors also tend to gravitate towards office and hotel assets and are less comfortable in the multifamily space, as evidenced by much less foreign capital in that sector.

Despite a smaller turnout than expected, the RealShare National Investment & Finance Conference was informative and provided some solid networking opportunities. For part 1 of this blog, please click here.

We recently attended the Realshare National Investment & Finance conference at the Omni Hotel in in downtown Los Angeles. There were a number of topics covered including the current state of the capital markets, loan programs and underwriting standards for various types of capital sources, the overall economy in relation to commercial real estate, and where institutional investors are finding yield.

In today’s market capital is readily available and aggressively chasing deals and there is no shortage of options for borrowers. Understanding the investor’s goals and objectives is key to securing proper loan program with the right lender.

Four panel discussions in particular were of most interest to me, and which I would like to focus on in this blog.
The first was titled: Winning Deals: What’s New in the Capital Stack? The panel members included: Philip Block, SVP of RealtyMogul.com; Jeff Hudson, CEO of George Elkins Mortgage Banking Company; Alexa Mizrahi, Loan Originator at Lone Oak Fund; Jason Fritton, Co-Founder & CEO of Patch of Land; and Barbara Morrison, Founder and President of TMC Financing.

The main focus of the panel discussion centered around the nuances between Life Company execution versus CMBS, SBA parameters, and the growing presence of family offices in the capital markets.

For those investors looking to lock in long-term debt, both life insurance companies and the conduit (CMBS) market are extremely competitive options. CMBS is able to provide higher leverage, at around 70% to 80% LTV depending on the type of asset, and is open to financing properties in smaller and tertiary markets, as well as older or “C” class properties. They can offer interest only payments, sometimes for the entire life of the loan, and typically have a 30 year amortization schedule, providing maximum cash flow to the borrower. Life insurance companies are typically maxed out at 65% LTV, have shorter amortization periods (20 – 25 years) and prefer larger core markets and class “A” and “B+” assets. However, in today’s extremely competitive lending environment it was noted that life companies are not as core-oriented as they once were and are more open to listening to “stories” for properties that may have not traditionally fit within their credit box. Despite the lower leverage and additional asset and location fickleness, life companies do provide some advantages over CMBS. Life companies tend to price about 10 – 25% inside CMBS, they do not have the reserve holdback requirements found in CMBS loans, they offer greater prepayment flexibility with a Yield Maintenance or step-down structure versus the defeasance commonly found in CMBS, have less cumbersome loan documents, and there is no 3rd party loan servicer which can be a point of frustration for many CMBS borrowers.

Another popular source of capital is the Small Business Administration (SBA). The purpose of the SBA is to encourage job creation. It lends to owner-users who occupy at least 51% of their property, and can finance both new construction and existing properties. It allows borrowers the ability to obtain up to 90% LTV financing, along with offering longer term, fully amortizing loan programs. The SBA used to only lend to borrowers with a net worth less than $5 million but has recently removed that restriction, opening up this source of capital to a wider pool of borrowers. With a focus on owner-users, it is surprising that the SBA is also very active in the hospitality space. The caveat is that the hotel must be owner managed. Another fact that many people do not realize is that the SBA will only refinance short term debt of 3 years or less, so for borrowers facing a long term loan that is maturing, the SBA is not an option, even if they meet all the other criteria.

Life companies, CMBS, and the SBA have been active in the commercial real estate lending space for quite some time, however the newest and most dynamic source of capital are family offices. Family offices are sprouting up across the country and are typically created by high net worth individuals emanating from other businesses or industries who are looking to put their money to work through commercial real estate lending and investing. Family offices provide real estate owners and operators with both debt and equity for their projects. They are often much more creative and flexible than traditional sources of capital and can even offer credit enhancements to sponsors who lack balance sheet strength, usually in consideration for some degree of back-end profit participation. Tower Capital has built relationships with a number of family offices that have been able to provide capital to our clients where traditional lenders have either not found a way to get comfortable with the transaction or have not been a good fit given the intricacies of the deal.

The next panel of interest was Debt for Every Deal: Lessons in Lending. The panel was moderated by Robert Hodge, Senior Director for Marcus & Millichap and included Karine Clark, Senior Director of Lending at Bolour Associates; Eric Ealy, Western Regional Director for Freddie Mac; Adam Petriella, EVP at Coldwell Banker Comercial Alliance; Kevin Pleasant, Regional Manager for Comercial Mortgage Lending at Chase; Michael Sanchez, Vice President of Colony Capital; and Jeffrey Weidell, President of NorthMarq Capital.

Chase Bank’s commercial mortgage lending division is mostly active along the west coast, Chicago, and Boston. They are a high volume lender and I was surprised to learn that for such a large financial institution their average loan size is only about $2 million. If your deal fits within their credit box, they can be an extremely competitive source of very low interest rates. Mr. Pleasant noted that the low interest rate environment has created a lot of demand for early refinances and that he expects spreads to possibly tighten in 2016.

Given the amount of multifamily volume we transact at Tower Capital, I was extremely interested in the insights offered by Eric Ealy, Western Regional Director for Freddie Mac. As early as late April, there were concerns that both Fannie Mae and Freddie Mac, two of the main sources for multifamily financing in the U.S., were already approaching their annual lending quotas of $30 billion a piece. This lead to a substantial increase in spreads in order to slow down the pace of originations and got a lot of people nervous since both the agencies have been such an attractive source of low interest, non-recourse financing. Mr. Ealy assured the crowd that Freddie Mac “has plenty of money to lend.” To combat the quota problem Freddie Mac has adjusted what is now covered under the caps. Small balance loans under $5 million, affordable and manufactured housing, properties under 50 units, and legacy loans which are already in Freddie Mac’s portfolio will not count towards the $30 billion cap. In fact, at Tower Capital we are currently seeing very aggressive pricing for these categories; as much as 40 basis points below normal pricing. Mr. Ealy noted that Freddie is already at about $33 billion in total loan volume this year and he expects that number to reach upwards of $45 billion by December 31st.

With total market transactional velocity already reaching peak 2006 – 2007 levels, the agencies aren’t the only lenders who have been busy. Jeff Weidell of NorthMarq, stated that the life companies are already becoming constrained and anticipates many of them reaching their quotas well in advance of the year’s end.

The general census of the panel was that underwriting is still remaining fairly disciplined, and the influx of capital to the market will continue to put pressure on interest rate compression. The panel has also noticed more cash out requests by long term owners who are taking advantage of today’s still historically low interest rate environment.

Stay tuned for next week where we will cover the insights offered by Warren De Haan, Founder of ACORE Capital; Paul Feinstein, Managing Director of Wealth Management at UBS, Christopher Flick, SVP at PIMCO, and many more during panel discussions titled: Power Panel: Direct from the C-Suite and In Search of Yield: The Outlook for Investment.