As the marketplace has grown increasingly competitive, with more lenders flooding into New York, banks and other lenders are issuing loans on projected income — known as a pro forma — rather than on the existing cash that building owners are raking in. In addition, lenders are providing loans to less experienced developers, and requiring fewer (or no) personal guarantees, sources said.
While the lending environment for borrowers has steadily improved since the economy began recovering from the recession, it’s now starting to look a bit more like the boom times of 2007.
“People are willing to accept a lower return for the same level of risk,” said Ronnie Levine, managing director at Meridian Capital Group, widely considered the most active commercial mortgage brokerage firm in the city. “[It’s] just another indication of the appetite for risk increasing.”
Levine was quick to add, however, that “I don’t think we are back to the high point on risk.”
These new rules of financial engagement offer a sharp contrast to the lending landscape in New York City’s commercial real estate market just a few years ago.
At that time, developers would typically have been required to pony up 20 percent to 30 percent of the equity in the deal. But that amount has fallen drastically, said Ayush Kapahi, a principal with Manhattan-based financial advisory firm HKS Capital Partners. Today, traditional lenders are often satisfied with developers putting in just 5 percent of the equity. On a $100 million project with $20 million in total equity, a developer might have to risk just $1 million themselves.
“The developer’s skin in the game is still required, but the amount of skin has diminished,” said Kapahi, whose firm arranged a $25 million first mortgage for a NoMad hotel at 11 East 31st Street last year.
For lenders and borrowers, it’s been a grueling path back. In the throes of the recession, of course, sales and lending transactions froze. In 2009, brokerage Massey Knakal Realty Services noted that there were just $6.2 billion in commercial real estate sales in New York City, and loan data tracking firm Trepp reported there were no commercial mortgage-backed securities issued. By comparison, last year there were $37.6 billion in sales, according to Massey Knakal. Trepp reported nearly $12 billion in CMBS (see related story, “CMBS turn toward trophy buildings”).
Examples of the easier credit landscape abound. In December 2011, HSBC Holdings issued Vornado Realty Trust a $330 million mortgage on its 1-million-square-foot office building 11 Penn Plaza. Not even two years later, in November 2013, Wells Fargo and UBS lent the REIT $450 million to refinance that old loan — increasing Vornado’s debt by 36 percent and underscoring banks’ appetite for risk.
The riskier lending landscape is nowhere more apparent than in the availability of mezzanine debt and preferred equity. It’s those riskier positions that get wiped out before traditional lenders’ capital if the market tanks or something goes financially awry on a loan.
All of these lenders are chasing relatively few deals, pushing interest rates down.
“Risk is returning to the market, as evidenced by spreads on all real estate types having seen a precipitous decrease,” said Bobby Bakhchi, president of Midtown-based mortgage brokerage Hybrid Capital.
Rates have dropped for both safer and for riskier deals, the former by about 1 point, and the latter for slightly less than that.
“In tertiary markets, for ‘story-related’ properties — meaning properties with sound real estate fundamentals — conduit spreads have come down [as well],” Bakhchi said.
The price is right
For all commercial property types in Manhattan, the average sales price per square foot increased by 60 percent between 2010 and 2013 to $1,040 per foot, according to Massey Knakal’s statistics.
Skyrocketing retail rental rates were one of the main drivers pushing up sales values last year. For example, Vornado, Highgate Holdings, Crown Acquisitions and others purchased 650 Madison Avenue for $1.3 billion, for a record $2,235 per foot for an office building.
The rising prices are allowing lenders to take risks, because they believe they can get out with their principal, cushioned by rising values, if the project flounders, Kapahi said.
Aby Rosen’s Seagram Building, at 375 Park Avenue in the Plaza District, is a good example of how lenders are willing to underwrite pro forma. The building’s May loan, most of which was sliced up for the CMBS market, provided Rosen’s RFR Holding with a loan of $789 million, based on $74 million in projected net operating income.
That figure is about $20 million above the actual $54 million in net operating income the building generated for 2012, according to Fitch Ratings. But with rising rents in the neighborhood, the CMBS originators (Citigroup and Deutsche Bank) were counting on the NOI to jump.
Significantly, it’s not just Manhattan where lenders are getting more aggressive.
High expectations for the Brooklyn office market have also prompted lenders to issue loans on speculative rents, or on properties with vacancies, in that borough.
Madison Realty Capital’s Managing Director Josh Zegen said he knows of recent loans in the borough that were underwritten with the expectations for a growth in rents, instead of at the current rental income.
“We are starting to see Brooklyn office deals where lenders are willing to take more speculative risk,” Zegen said. “There is more pro forma lending going on than a year ago. Maybe not like 2007, but definitely more than there was.”
Retail rents have jumped in Williamsburg, fueling lenders to underwrite higher values. In 2011, Joseph Cayre’s Midtown Equities and investor Joseph Tabak were dueling over 242 Bedford Avenue, a bankrupt development site. They were bidding as much as $22 million at the time. A year later, Cayre, along with his nephew Bobby Cayre and the Adjmi family, purchased the site for $23 million. And last year they obtained a first mortgage for $28 million.
“With more money chasing deals, you end up with more aggressive terms,” said Daniel Hilpert, managing director at Brooklyn-based Mortgage Equicap, a debt and equity broker.
In general, life insurance companies charge owners the lowest interest rates, and private lenders the highest, but each deal depends on the underlying value of the project, sources said.
Bigger risk, smaller reward
“Investors are willing to get paid less for that higher risk,” said Hilpert.
For example, preferred equity providers are accepting lower returns. A year ago, an investor looking to place preferred equity might have expected to receive a 15 percent annual return for his or her outlay, plus about 50 percent of the upside. “Today, on the same deal, you would see a 12 percent [annual payment] and 20 percent of the upside,” said Hilpert.
In the post-recession world, lenders were typically providing loan-to-value or loan-to-cost ratios — the amount of loan compared to the value or cost of the asset — no higher than 60 percent, meaning that lenders were putting up just over half of the value or cost. (The higher the percent, the riskier the loan is for the lender.)
Today, loan-to-value ratios have risen sharply.
HKS’ Kapahi cited a $100 million loan he was arranging last month for a Manhattan condo conversion project. Two years ago, such a deal would provide a loan-to-value ratio ranging from the mid-50s-percent to the low-60s-percent for the first mortgage, whereas today it’s up to the low-70-percent range, he said.
In addition, when factoring in all borrowed capital, including mezzanine and preferred equity, those ratios have crept to more than 90 percent in some cases over the last few years.
This newly competitive landscape has also prompted lenders to accept lesser guarantees from borrowers. “There is a lot of non-recourse money,” said Hilpert, referring to a loan in which the borrower is not personally liable, although is on the hook to finish the construction. “There are hardly any repercussions if a project fails.”
That came back to burn lenders in the downturn, when many borrowers were not incentivized to keep working on newly underwater projects.
Simon Ziff, CEO of financial advisor Ackman-Ziff, said that in addition to forcing down rates, the competition to place money in the market is fundamentally altering the deal structure for debt and equity providers.
“Both debt and equity sources are having difficulty getting their money out, and each is willing to look a little like the other in order to creatively deploy capital,” Ziff said.