The Real Deal New York

Shining a light on loan to own

Lenders offer money at higher rates, increasing chances of default and foreclosure

April 01, 2009
By Adam Pincus


Go to chart: Interest rates by lender type

In the world of real estate finance there is an ambiguous and maligned concept called “loan to own.” Everyone acknowledges it exists, yet no one admits to participating in it.

To be labeled a “loan to own” shop — or a lender that swoops in to finance a project at extremely high interest rates while hoping for a default — is considered an insult, real estate professionals said. They said no lender wants to be known as an institution that anticipates their loans will fail so that they can stand to gain ownership of the property.

“No one goes out and says, ‘I am making a loan to own,’” said Andrew Gold, a partner at the law firm Herrick Feinstein.

However, there are several types of lenders most often identified with the term, such as hard-money lenders, hedge and private equity funds and private individuals. And, as banks recoil, many developers have no choice but to tap less traditional sources of funding.

In the hard-money arena, sources pointed to Kennedy Funding and Meecorp Capital Markets, both of New Jersey. Funds such as private equity firm AREA Property Partners (formerly Apollo Real Estate Advisors), and hedge funds such as Blackacre Capital are also mentioned. Additionally, there are private business executives who make loans.

Kennedy, AREA and Meecorp all told The Real Deal that they do not engage in loan to own. Blackacre did not respond to calls for comment.

Although the definition of loan to own would seem straightforward — the lender provides financing at a rate so high that probability of a default goes up — it depends on a reading of the structure of the loan. What is open to interpretation is the intent of the lender, and whether the loan terms are onerous or simply reflect the lender’s risk. Whether the lender is a white knight who saves the troubled deal, or a loan shark hoping for it to fail, is in the eye of the beholder.

“Loan to own has a different meaning for different people,” said Frank Mancini, executive managing director at real estate services firm Grubb & Ellis. “Typically it is mezzanine or preferred equity on a property they would like to own. The terms are a little more aggressive. The lender is happy to own it if there is a default, but if it doesn’t default you have a performing loan.”

Real estate attorney Edward Mermelstein had a narrower definition, excluding many well-known hard-money and fund lenders. He said true loan to own deals were financed by wealthy individuals who have cash available. He knew of about four people engaged in such lending recently in New York City, but declined to identify them.

They are “individuals with significant liquid assets who are known to lend money on real estate deals,” he said.

In one loan to own-type case, Dorothea Keeser, the founder of the Chelsea Art Museum, accused a division of Swiss banking giant UBS AG of trying to “steal” her museum’s building at 556 West 22nd Street at 11th Avenue. The bank’s UBS Real Estate Investments lent her company 556 Holdings $5.8 million in May 2005, in a short-term loan to pay off another bank’s mortgage. She eventually defaulted, and is suing for $12 million to recover payments and for damages.

The bank wanted to take advantage of her naivete, her complaint said, “in order to ‘steal’ what was a very valuable piece of property from underneath her.”

“If [Keeser] defaulted, UBS stood to gain an extremely valuable asset for relatively minor cost, one that could generate tens of millions of dollars in profit,” said her lawsuit, which was filed last month in Manhattan State Supreme Court. A spokesperson for UBS declined to comment.

Lending in tough times

As the economy has soured and credit has dried up, New York developers in dire straits have turned to hard-money lenders.

Daniel Edrei, director at hard-money lender Meecorp Capital Markets, said most of the lending occurring in the city is not coming from banks. “Basically, the great majority of lending that is going on right now is private money,” he said.

While a traditional first mortgage would charge an interest rate of about 6 or 7 percent, mezzanine lenders typically charge 9 to 15 percent, and hard-money lenders can charge up to 16 to 18 percent or more. Lenders also charge points — each point is a one-time fee equal to 1 percent of the loan value — starting in a range of 1 to 3 points and escalating upwards.

When Chinatrust Bank cut off construction financing near the completion of a residential development in Brooklyn last fall after a dispute concerning an unrelated project, developer Alexander Gurevich turned to a New York City firm, AB Funding, for a $1 million mezzanine loan. He would not say exactly what rate he was paying to complete the project at 4102 13th Avenue in Borough Park, but he said hard-money lenders were getting rates in the high teens.

“It is very difficult in this economy to refinance an unfinished building. We had no choice,” he said.

Edrei said the bank stopped lending at one New York City condo conversion project, but the developer had substantial equity in the project as well as presales, so was willing to pay Meecorp a high interest rate to keep it running.

The developer “would lose it if it didn’t get financing. We came in as the mezzanine debt,” he said.

John Hornik, executive vice president and general counsel of Hackensack, NJ-based Kennedy Funding, said his firm specializes in bridge loans starting at about 9 percent with three points. “We are not what you call loan to own guys,” Hornik said.

His firm announced in September a $5 million loan for the 21-unit luxury condo at 23 East 22nd Street in the Flatiron District by developer 24 East 23rd Commercial. The developer needed the money to continue construction.

He added: “To be clear, our first course of action is not to foreclose, but if there is no other alternative, we will exercise it.” Despite the option, Kennedy has not foreclosed on any properties in New York City during this downturn, he said. The company has foreclosed on properties in the past.

Justifying loans

Jon Estreich, a founding partner and principal of RCG Longview, which makes high-interest loans, said that rates were justified because such lenders did not use leverage.

“We lend money based on equity. You are getting charged for your risk right now,” he said.

But with the stalled economy, more and more lenders are considering foreclosure or other means to take possession of properties that in many cases have declined in value.

Mancini, head of the distressed asset department at Grubb & Ellis, said it was a trend in New York City that would only grow. “These loan to owns, they are still performing, but the time is coming. It is probably sooner than later where they are going to start to be in a little more trouble,” he said.

David Schneiderman, a director at Ackman-Ziff Real Estate Group, said preferred equity and mezzanine debt, whether in a loan to own-type deal or not, have slightly different structures that allow the lender to take control of the asset. A key difference is the preferred equity allows the investor to take control of a property without foreclosure because preferred equity is included as part of the operating agreement.

A holder of mezzanine debt, on the other hand, would most often have to foreclose to take title of the property, Schneiderman said. In fact, some hard-money lenders have begun to foreclose on their loans.

Edrei said his firm, which lends nation ally at a rate in the low- to mid-teens, was foreclosing on about $15 million worth of loans in New York City out of a total of about $50 million in the five boroughs.

“You know when we foreclose usually we get a much higher return than on our good-paying borrowers,” he said. However, he noted, “We would rather just lend and service the debt … I’ve got to look at myself in the mirror at night.”

Real estate professionals also pointed to the $135 million mezzanine loan Apollo Real Estate Advisors, now AREA Property Partners, made to Africa-Israel Investments and Mann Realty, which bought the Apthorp on the West Side in 2007, planning to develop it into condos.

AREA and the first mortgage lender Anglo Irish Bank threatened to foreclose on the owners unless they came up with $23 million in additional equity. The strong-arm tactics by the lenders to control the property, ultimately replacing Mann with a new manager, is an example of elements of loan to own, experts said.

Bradford Wildauer, a partner at AREA and head of its debt group, said the private equity firm’s action was not taken to acquire the Apthorp, but rather to make sure it was run better. AREA’s lending funds have not taken control of any New York City projects during this downturn, although they have before.

“We are not afraid to get the keys back, but first and foremost we would [rather] have the borrower run their project and we get repaid,” he said.

Today, many mezzanine or equity lenders are running the numbers to determine whether they should make a move to take back the properties, or in some cases, walk away and leave the building to the first mortgage holder.

Eric Anton, executive managing director at Eastern Consolidated, said the lenders are discussing whether they should fight to foreclose to take title, or just give up the keys to the bank.

“I can foreclose and take the building back, but do I want the building? I may just walk away because the building is worth so much less,” he said.

“In the boom time, some lenders were arrogant and said, ‘I will just take the building back.’”

But, Anton noted, with values down 40 to 50 percent, lenders might not want to end up owning after all.

Comments are closed.

MENU

Subscribe to our email newsletters

New York Real Estate News
South Florida Real Estate News