Condo development gets investment banking boost

Nov.November 26, 2007 01:32 PM

In New York, Wall Street money usually accounts for seasonal real estate booms when bonus money fuels the annual spate of high-end apartment purchases.

Now the financial sector is getting in on the real estate boom at a more basic level, as real estate developers seeking construction financing tap investment banks as a source of loans for condo projects.

Thanks to shifts in how banks securitize loans, by spreading the risk around using financial instruments called mortgage-backed securities, these lenders are getting in at the ground floor of new construction and, in New York, moving into lucrative condominium conversions.

In mid-October, Credit Suisse First Boston announced a construction loan commitment of $1.25 billion for the Bungalows Flats Residences at the Hard Rock Hotel & Casino in Las Vegas the largest residential condominium financing in North America to date. The project will add 1,350 residential and resort condominiums that will triple the size of the resort.

Credit Suisse has plans to syndicate out a portion of the loan into a pool of commercial mortgage-backed securities, said property developer Christopher Milam, president of IDM Properties.

It will be the first time Credit Suisse has syndicated a construction loan, but the firm has already been involved in financing conversions, including in New York. Last spring, Credit Suisse syndicated seven loans to developers converting properties to residential condos.

Those projects included the Sheffield, the 845-unit building at 322 West 57th Street, which a partnership of Swig Burris Equities, YL Real Estate Developers, and S & H Equities is turning from rentals into condos.

Conversion and construction financing represents a new direction in lending by investment banks because it involves higher profit margins, says Andrew Oliver, managing director at Sonnenblick-Goldman Company.

“Many lenders traditionally don’t grant construction loans for condominium conversions; however, after recognizing the great success of these types of projects, they are now shifting into this higher margin business,” Oliver said. “They first did fixed-rate loans, and they started doing floating-rate loans. First, you couldn’t securitize those, and then you could, and this is the next step to get involved in construction loans.”

Oliver recently worked with Bear Stearns to finance two conversion loans in New York, though they will not be securitized. The first was a non-recourse $17 million, 24-month, floating-rate mortgage for the acquisition and conversion of a turn-of-the-century industrial building into 16 high-end condos at 209-211 Hester Street. The second financing, arranged in October, was a $95 million, non-recourse loan to the Westport Group for the acquisition and redevelopment of 650 Sixth Avenue, a six-story loft building in Chelsea.

While investment banks still want equity up front, they want less than a commercial bank, Oliver said. Also, he added, they’ll loan higher loan-to-value than a commercial bank, as well as non-recourse, meaning the lender has claim only against the partnership as a whole and not against individuals.

“That’s their competitive edge against some of the banks,” Oliver said. “One of the reasons they’re doing this is because the profit margins on typical securitized loans are so thin, and it has become so competitive, this is a way to have a higher profit margin and differentiate themselves with a new product.”

Investment banks push borrowing envelope

In a race to cash in on the hot residential development market, investment banks are pushing the envelope in how much they’ll finance to attract property developers.

Mark Edelstein, a lawyer with Morrison & Foerster who specializes in real estate finance, said some investment banks are advancing the full amount of a construction loan without having the developer put in any equity up front.

Traditionally, after the borrower puts in equity, the construction loan is released in dribs and drabs as the developer needs the money.

“Typically, the investment banks will require some sort of letter of credit instead from the developer,” Edelstein said. “So the borrower says, ‘I’ll put in my equity later, in some other form, but to guarantee that I’ll do that, I’m providing a letter from another bank, and if I don’t put my money in, you can draw on the letter of credit.'”

The arrangement is an unusual one, but one that can be highly advantageous to canny borrowers, he said.

Another type of construction loan done through the commercial mortgage-backed securities market, which has been offered to property developers for a number of years, is a “fully-funded construction loan.”

The Canadian Imperial Bank of Commerce (CIBC), a commercial investment bank which offers this type of loan, advances the construction loan monies into an escrow account, from which the developer draws on a monthly basis. At the end of the project, the bank has a cash-flowing asset that can be securitized.

But one problem for New York City’s residential developers is that CIBC does not finance condominiums.

“Basically, we prefer cash loan properties office buildings, retail, as well as multi-family, but we probably do more retail and office than multi-family,” said Michael Higgins, managing director at CIBC.

Another issue is that negative arbitrage plays a role in New York, meaning the developer has to pay interest on the money in the escrow account. For a large long-term project, that can add up.

But Higgins said the bank works with developers doing larger projects by allowing the interest rate to float and only fixing it in on each monthly advance once it happens.

“We’re very flexible like that, because we can do all types of lending,” Higgins said. “Then the developer can cut down on the negative arbitrage, but he is taking some interest rate risk.”

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