An investor’s decision-making process focuses on underwriting real estate as the primary driver.
In continuing our discussion from Commercial Real Estate’s Status, $10MM is the New $100M, Part 1:
Regarding Institutional Investors
• Most of them were out of the market for the past 3-4 years because there was an excessive amount of capital in play, driving terms below what was considered reasonable.
• There were only willing to consider Credit Tenant transactions – true Investment Grade Tenants, signed to a lease of 15 years or greater, on an Absolute Net basis, with pricing based on the spreads displayed in the corporate bond market.
• While corporate credit is key, real estate fundamentals must be present: Market rents, market pricing for $/sf of building, etc. Mentioned that they were very inactive and stressed that credit is everything in their underwriting.
• There is a large amount of uncertainty over the implied pricing of a large transaction in today’s market, thus funding a deal over $50MM requires an “act of god.”
Comments on the Private Market
• An investor’s decision-making process focuses on underwriting real estate as the primary driver, including an understanding of market rental rates, reasonable building and land costs, and reasonable re-tenanting for alternative use.
• The large premium for purchasing a real estate asset that includes an income stream has been largely eroded.
• The days of purchasing retail bank branches paying $80/sf in rent when market is $20/sf are over.
• Private market players generally have a depository relationship with a local lender that is still providing relatively aggressive loan terms, although it is full recourse.
What are the New Realities of Debt Financing?
• The Commercial Mortgage Backed Securities (CMBS) market is flawed.
• The world as a whole is over-leveraged
• A borrower will have to pay a significant premium over an “A” product to get non-recourse.
• Current rates vary between 5% to mid 6% for recourse money but some lenders will do non-recourse at low leverage at roughly 7%+.
• If the CMBS market comes back, the syndicating bank will have to remain in the deal potentially holding as much as 20-30% of the paper.
• As an alternative to the CMBS market, lenders and capital sources are actively working on a solution but it will take some time to form a new and proven product.
What Deal Criteria Would Financial Institutions Presently Pursue?
• A $60MM deal for an “A” rated tenant will require 4 separate lenders to fund the transaction.
• A True Credit Tenant Lease deal on a Sale-Leaseback or Build-to-Suit terms.
• The building would need a true Credit Tenant, with 15+ year NNN lease through either a Build-to-suit or Sale-leaseback transaction.
• Alternatively, a strong credit-tenant with strong real estate fundamentals on a basic 70% LTV transaction.
Part 3 will cover Net Leases, Medical Office, underwriting credit, tenant retention strategies, and will summarize the status of the commercial real estate. Stay tuned!
Where Have all the Commercial Lenders Gone?
Government Agency guaranteed or sponsored transactions, including: SBA 7(a) and 504, HUD construction loans for multifamily projects, Community Reinvestment Act loans, USDA Business and Industry loans, and to a lesser extent, Fannie Mae and Freddie Mac multifamily loans.
Trading Up Using the 1031 Exchange
A powerful method for building real estate holdings is the use of 1031 Exchanges, which lets investors defer capital-gains assessment on investment property.
Segregate Costs for Better Cash Flow
While costs such as office equipment and furniture are easily recognizable as personal property, construction-related costs that are often included as part of real property may also qualify.
