Money Talks
May 1, 2009 12:00 PM, By Elaine Misonzhnik
Regional and local banks, private equity players and foreign financial institutions still have money to lend for retail real estate.
Palisades Financial's got money. The Fort Lee, N.J.-based commercial real estate lender has allocated at least $100 million for deals in the near future, including on retail properties. The firm currently manages several funds totaling $1.4 billion.
Palisades Financial wants to lend and can work with borrowers on short notice to refinance maturing mortgages, says David McLain, a Palisades principal. So why is it that the last retail-related loan the company completed was several months ago, on a condominium building in Jersey City with a restaurant and some retail space downstairs?
The problem is that most of the requests for financing that Palisades receives are either for properties with weak fundamentals or to refinance loans with exuberantly optimistic underwriting. Under these circumstances, Palisades' deals don't pencil out and more often than not, it doesn't feel comfortable lending, McLain notes.
Given the current pace of vacancy increases, declining rents and loss of confidence in the viability of some tenants, even a fairly conservative mortgage that featured a 55 percent loan-to-value ratio in 2005, when it first closed, might be viewed as having loan-to-value ratio of 80 percent in 2009 because of how much values have eroded, says Gregg Winter, founder and managing partner of W Financial, a New York City-based private commercial bridge lender. This dynamic is exacerbated in those cases where the original loan was made at 75 percent or 80 percent leverage. Many of those loans can't be refinanced today when underwriting focuses on in-place rather than prospective income, Winter adds.
Players like Palisades Financial, which still have capital at their disposal, want to make sure they'll get a return on their investment — after all, they can get double-digit yields by buying into AAA-rated tranches of commercial mortgage-backed securities (CMBS): instead of originating whole loans, which offer returns in the single digits. (The drawback to buying CMBS bonds is that nobody knows how long it will take to reap those double-digit returns.) So they lend only on top-notch assets, with strong current cash flows, fail-safe tenants, locations that will remain in demand under any market conditions and stringent underwriting on the original loans.
Palisades Financial is not the only company to find itself facing a lack of attractive deals. For example, W Financial has a healthy appetite for building up its loan portfolio, but the last retail deal the company closed was back in December, on an 11,862-square-foot retail condominium in the middle of Manhattan's fashionable Meatpacking District. And the only reason that deal happened was because it had everything in its favor: low leverage, high-net-worth borrowers with a long track record in retail real estate, a market with extremely high barriers to entry and a location that was so desirable, it was certain to attract tenants no matter what.
Still, when W Financial underwrote the value of the property, it projected that future rents might come in $100 per square foot below the levels currently achieved by similar properties in the area, says Winter. Currently, equivalent retail space in the Meatpacking District leases for at least $250 per square foot. With the economy in a deep recession and national retailers going out of business every day, Winter's fund has been staying away from retail loans unless the underlying properties are located in the heart of first-tier cities like New York, Boston or Washington, D.C.
In a world post-Lehman Brothers bankruptcy, “How do you know who a credit tenant is, or will still be a year from now?” Winter says. “I think every lender looks at the roster of tenants in a retail property and is nervous about how reliable the [landlord's] income streams are going to be.”
Winter, who also serves as president and CEO of Winter & Co., a New York City-based commercial loan placement firm, can attest that some regional banks and insurance companies remain in the lending market for retail. But the kinds of properties they target and the loan terms they offer have changed dramatically from the mid-2000s.
Last month, for example, Winter & Co. arranged a $9 million loan on a 150,000-square-foot mixed-use building in downtown Brooklyn that features 10,000 square feet of retail. The loan, from a regional bank, came with a 6.75 percent fixed interest rate and a 10-year term. But the loan-to-value ratio on the $40 million property was less than 30 percent.
Those owners fortunate enough to meet lenders' criteria have to accept new rules of engagement. At the peak of the boom, it was possible to get financing well above 90 percent. Today, nobody stands ready to offer leverage levels greater than 70 percent, says Bob Bakhchi, CEO of Hybrid Capital Markets Inc., a New York City-based commercial mortgage brokerage and advisory firm. Interest rates range from 6.5 percent on the smaller deals to 8.0 percent on the larger deals with loans provided by a local or regional bank and from 7.0 percent to 9.0 percent when loans are provided by insurance companies like Prudential Mortgage Capital. Two years ago, interest rates on retail properties ranged between 6 percent and 7 percent. Most lenders also require debt-service coverage ratios of 1.20 to 1.35, according to Bakhchi, compared to ratios that hovered around 1 during the boom.
The 180-degree turn in underwriting standards from the mid-2000s might leave even borrowers with good credit in a lurch, says Winter. Those who secured reasonable loan terms in 2005 and 2006 should be able to refinance but might come short of the whole amount of their loans. To make up the difference, they might be forced to give up part of their ownership of the property to joint venture partners. Those who levered sub-par centers up to 90 percent with conduit loans will likely have to hand over the keys to their centers to special servicers.
“In this market environment, anyone who's putting out first mortgage money has to assume the worst — that the value will decline, that cash flow income might erode,” says Winter. “Today's 50 percent loan to value might turn into tomorrow's 75 percent.”
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