Real estate financing is in the perfect storm

If you think acquiring financing for developers and investors is not getting any easier, you are right. Yet hope is on the horizon.

According to Ed Wlodarczyk, senior vice president and head of capital market services at DTZ, Americas, they are coming out of the abyss with the frozenness of the banks, and the lending environment.

“I think construction financing is still not at the levels that we remember it being,” he said. “I’m currently working on two large development projects out West, I am still having a difficult time with them, and these are great projects. One is a golf resort, single-family community south of Tucson in Arizona. The other is a mixed-use main street project. The lenders are still skittish on the developments.”

He continued, “I believe sponsor/developers who do not have a solid relationship and track record with a financial institution are more likely to seek out a private equity company. Although private equity may be a little bit more expensive, it will allow the project to commence. Private equity firms usually have an end game, whether it is a REIT rollup or an investment sale, private equity will be a short term fix.”

After 26 years in the business, Wlodarczyk knows the industry well, and says that multifamily has been on fire all throughout the United States.

“Due to Freddy and Fannie being very aggressive for multifamily housing financing, that market has been open for business the last five years without missing a beat,” he said. “A lot of people after the crash changed their strategy and started investing in multifamily because it’s easily financeable. Plus when you think about multifamily, when people were losing their homes due to foreclosure or credit lending, people had to live somewhere.”

He added, “Regardless of the economic situation we have to have somewhere to live, you have to eat, and you have to have clothes.”

Wlodarczyk says industrial comes next, retail follows, and then office is last.

“Development is taking a risk. So the lending communities of the world are sitting back and saying what are my greatest risks? Or what is my greatest risk? If my easiest risk is multifamily because the government’s allowing me to do it with the Freddy and Fannie type of financing that is available, then I should do that.”

Another aspect to financing people were looking towards, Wlodarczyk says even when the markets collapsed, was new market tax credits.

“New market tax credit allocation is the government’s approach to provide for redevelopment of communities and the re-gentrification of communities within the United States. A good friend of mine, Neil freeman of Aries Capital here in Chicago, has become a leader in this arena.”

Another form of financing that can be used for development is a credit tenant lease (CTL). Wlodarczyk said that is where the owner signs a lease for 20 years. The credit of the tenant must be investment grade or higher to be considered for a CTL. The lenders prepare a bond instrument out in the financial community, not using the value of the real estate, but on the credit of the tenant.

“Rates are very competitive with the right type of credit,” he added.

Also, there are several private equity funds available that are just doing construction lending for single-family, and there is a lot of activity in the residential multifamily arena.

“As it pertains to commercial real estate,” Wlodarczyk said. “If you look at our market in the Midwest, many long standing firms have survived by re-inventing themselves and adjusting to the marketplace. Because of that, when the lending community comes back and says we’re ready to go, they will be able to swoop in and do the things that they need to do.”

Interest rates are lower than they were at the high water mark commercial real estate in 2005 according to Wlodarczyk. As he reflected on conversing with a client looking to do a lease back, he says he told his client it was the perfect storm.

“It depends on the type of real estate and the credit of the tenant and borrower,” he said. “If it is a single tenant net leased property for 15 years to a Walgreens, one can achieve the lowest rate in the market, and if you choose to sell, don’t be surprised if the cap rate is lower than we achieved during the high water mark in 2005.”

So are we facing another bubble? Wlodarczyk says he does not know but he hopes not.

“I think there is a lot of runway left in this recovery. Originally when I did my forecasts for the firm in the fourth quarter of last year, I said interest rates would go up fourth quarter of this year. I am now saying that interest rates will most likely go up in the second or third quarter of 2015. If they do go up, they’ll go up marginally because the activity is promoting itself to move forward.”

CMBS is back, and the legacy 10 year mortgages are coming due next year, and the year to follow. Wlodarczyk says because the interest rates are low, most of those loans that need refinancing will be refinanced.

“The market place is completely different than it was six years ago,” he said. “Six years ago it was a churn and burn type of market, and there was no customer service. Today, customer service is better and life companies have better rates than the CMBS market does. Which six years ago, the CMBS market was easily 50 to 75 basis points lower in cost than the life company market.”

He says that there has been a shift, and it is okay, because it is a good one.

“Again, I still think we are in the perfect storm.”

So what do developers and investors have to be able to show lenders to improve their odds of getting financed? Wlodarczyk said there are four key components.

“If you’re looking for financing make sure you have a good handle on your project, you can show a track record which is important, you have to have skin in the game, and you will really have to prove your pre- leasing activity because it will be scrutinized by the lender.”

Since the economic downturn, Wlodarczyk says many people have changed their practices, and the banks, lenders, and developers are all smarter today because of it.

“In 2011 all of a sudden there was some movement, in private equity primarily,” he said. “Raising capital, doing mezzanine funds, or short term bridge lending with really high interest rates. Yet for people that needed to facilitate and execute a transaction, those folks were accommodators, and the interest rates were high, but people had to do what they had to do.”

He added, “Today, I think they are trying to come back. Those who did not reinvent themselves are either out of business, or now are trying to reinvent themselves, and it’s too late. That is also okay because this business is evolutional.”

Tags | Commercial Real Estate, DTZ, Ed Wlodarczyk

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