The Real Deal New York

Investment banks limp away from financing

Demise of Bear Stearns means obtaining financing for large deals harder than ever

April 01, 2008
By Adam Piore

The demise of the investment bank Bear Stearns means there’s one less lender around to finance pricey commercial real estate buys.

But the firm’s stunning collapse last month was only the latest negative development in a lending landscape that has become much tougher in recent months, and had already significantly driven up the cost to finance big commercial deals.

“Underwriting standards have tightened considerably, and it’s just harder to execute large transactions,” said Ron Gershoni, vice president of CRG Realty Capital, which specializes in structuring deals and raising capital. “It’s harder to find money for deals, and when you do find it, the lenders are just not as aggressive as they were before last summer, which is leading to a decrease in transaction activity.”

Robert White, founder and president of the research and consulting firm Real Capital Analytics, said, “The bigger the deal size, the tougher it is to get credit.”

That’s because investment banks, which for many years fed the real estate boom by offering easy credit, then packaging loan deals together in securities and selling them to investors at a profit, have limped away from that market.

When the words “subprime debacle” hit the headlines in August, the secondary market for those securities dried up virtually overnight, stranding tens of billions of dollars of unsold securitized loans on the books of the investment banks (as much as $50 billion, by some estimates).

There have been just two small securitizations so far this year: Bank of America syndicated $2.3 billion in February, and Morgan Stanley securitized $1.2 billion in March, said White. That $3.5 billion, which represents the first quarter of the year, is equivalent to just 17 percent of $20 billion issued in February of 2007.

“If you had a $100 million deal last year, Lehman and Wachovia would have been tripping all over themselves to give you a bridge loan, and then they would securitize it,” he said. “Now, no one is willing to take them on and try to syndicate them out. And there aren’t many lenders out there that are willing to commit several hundred million dollars to a single transaction.”

With securitization essentially frozen, many borrowers are instead seeking financing from so-called “balance sheet” lenders — large financial entities like pension funds (the California State Teachers’ Retirement System, which has been bankrolling Larry Silverstein’s recent transactions, is one example) and insurance companies. These entities are awash in cash, but they keep the loans on their balance sheets and operate under fundamentally different guidelines (see Smaller lenders fill big shoes).

While investment banks made money by getting as many deals out the door and onto the market as fast as possible, balance sheet lenders are seeking fixed rates of return and impeccable creditworthiness from their borrowers. They’ll finance the acquisition of a trophy office tower, but they will do so with stringent terms, demanding that more lenders put up more collateral and sink more money into the property.

Because these insurance companies and pension funds are carrying the loans on their books, industry experts say they are going to be more conservative with stricter underwriting standards and higher spreads.

Those higher spreads mean higher costs to borrowers. But it’s the tightening lending standards that are more costly.

Last summer, many lenders would issue 80 percent
or even 85 percent of a property’s valuation in so-called
“senior debt,” debt that gets priority in the event of
liquidation and is offered at lower interest rates. Now, underwriters will only lend about 65 percent of that valuation, forcing borrowers to make up the difference with more equity or to raise the rest through much more expensive mezzanine financing.

Lenders are also changing the way they calculate that 65 percent. Previously, they made loans based on a property’s appraised value, derived from the current and projected income and the selling price of comparable buildings. But they would later allow borrowers to recalculate that appraisal after adding property improvements, refinance the initial loan and withdraw capital from the project (they would count any increase in value as imputed equity). Now, they will only lend based on a percentage of the total actual project cost rather than the appraised value because they want to make sure borrowers continue to carry risk.

“What a lot of guys were doing was buying properties and refinancing in a year, and then taking all their money off the table,” CRG’s Gershoni said. “You can’t do that anymore. Lenders are saying, ‘We need to see that your borrowers still have cash in the deal.’”

Those factors coupled with the uncertainty about the overall direction of the market have led to a marked decrease in big deals. At the end of January, Real Capital Analytics was tracking about $10 billion in office deals under contract nationwide — Manhattan accounted for about half of that. But few of those were big deals. According to Dan Fasulo, managing director of the firm, Manhattan saw just $730 million in commercial sales in February, down from $1.4 billion in January.

Nationwide last year, 42 office properties sold for $100 million or more in January alone. This past January, only eight sold for that amount, White said, and portfolio sales
are down by 90 percent, as are big deals of any kind.

“We haven’t seen a big office portfolio trade, and we’ve seen very few $1 billion deals this year,” White said. “They were a dime a dozen last year. There was about one a week. But now, the large assets are the hardest to finance.”

There has been one big recent office tower transaction. Last month, when JPMorgan acquired Bear Stearns for $236 million (that figure was later adjusted upwards to more than $1 billion), it also got the company’s 47-story Madison Avenue office tower, valued at $1.2 billion. But that is anything but good news for owners of similar trophy towers in the city. The failure of Bear Stearns, and the mass layoffs expected to follow, has already led analysts to warn that concerns about the office market would soon begin to weigh on the shares of local landlords.

By some estimates, the average price per square foot to buy prime office space is already down some 20 percent from what it would have fetched at its peak during the market’s height. But the impact on the market has been muted so far, in part because many sellers are not desperate to unload their assets, observers said.

Since last September, said White, “we saw a slew of billion-dollar deals pulled off the market that couldn’t get closed because of the market. We’re still seeing deals falling out of contract.”

The Moinian Group and Westbrook Partners, which closed on 475 Fifth Avenue last April for $160 million, put it on the market it October and pulled it in early February, he noted, and the owners of the Roosevelt Hotel at Madison and 45th pulled it off the market in December.

Anthony McElroy, senior managing director at Colliers ABR, said the financing situation is driving interest in certain types of properties.

“In the last couple years, empty buildings with a lot of leasing to do were very popular and were going to get a lot of financing,” McElroy said. “People thought rents would keep going up at 10 or 15 percent a year. Now, people are thinking rents are flat at best, so leased properties are a little more popular.”

But the current conditions have been a boon to some. Max Herzog, senior vice president for CB Richard Ellis’ Capital Markets Group, said his office is “busier than it’s ever been” because putting together deals requires “more brains” to identify different sources of equity and lenders.

The conditions have also been good for lenders. While insurance companies like Prudential are getting the pick of the loan litter, lenders willing to take on subsequent layers of debt are benefitting, too. Mezzanine debt lenders who charged higher rates to take a borrower from 80 percent to 90 percent of the funds needed to do a deal (meaning they would only get paid in the event of a default after the borrower paid off the first 80 percent) are charging the same rates to take a borrower from 65 to 75 percent of the deal.

Equity players who couldn’t get into the game until a borrower had reached 97 percent of a sales price are getting the same deals at 85 percent, he said.

“I’m working with a lender that is typically a mezz lender or a joint equity lender who has now decided to do bridge loans,” Herzog said. “They’re getting senior debt on the deal when they wouldn’t even have been a candidate for the loan before.”

He said the overall impact, however, is to keep a lot of “people on the sideline.”

Tom MacManus, chairman and CEO of Cushman
& Wakefield Sonnenblick Goldman, said “a lot of people are reluctant to commit substantial sums to large transactions.

“The good news is, there’s a lot of money sitting on the sidelines leading to opportunity to put it to work when they feel volatility has eased,” he added.

As McElroy puts it: “Nobody is really in a rush. People are waiting. Nobody thinks they’re going to lose out on anything if they don’t pull the trigger today.”

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