From the April issue: Jonathan Genton
Founding partner and CEO, Genton Property Group
How have lending conditions in the L.A. commercial real estate market changed over the past year?
Most definitely they have tightened, especially in the apartment market, which has been the best segment over the last several years. For multifamily, you’re getting less in proceeds, less in interest rates, higher debt-to-coverage ratios. Lenders are not letting us trend rents, where you assume rental growth. They’re keeping you flat.
All in all, they’re just reducing their exposure generally. In the past, we could get 70 to 75 percent loan-to-cost. Now we’re seeing that in the 60 to 65 percent range, if you’re lucky. And that’s all recourse. One hundred percent of the guys we talk to are recourse lenders. They’re becoming much, much more conservative.
What do capital stacks look like here, and how has that changed recently? What percentage of equity do developers need to put down?
We’re trying to get 85 percent of our costs financed one way or another. In the past, lenders might do 75 percent, and that was easier. You had limited recourse on that. Now I see full recourse from the traditional banks, if they’ll even do multifamily given concern about supply.
If lenders go down to 60 percent, that leaves a gap. But that’s also given birth to some pretty interesting alternatives in mezzanine lenders or private equity coming in to fill that gap. But their cost of funds, depending on who it is and your asset and submarket, is probably costing you 9 to 14 percent.
Generally, you see the banks are much more conservative. There is the famous Bank of the Ozarks, which is the last of the last doing multifamily nonrecourse loans. But they’re getting the last look at anything, too. I’ve never financed with them, but I know they’re out there.
Who are the primary lenders to luxury condo developments in L.A. these days? We don’t see many, if any, traditional lenders in a high-rise condo project.
The banks — in terms of high-end luxury for-sale condos in a tower — are somewhat absent in the market. They see risk in a high-rise for-sale product and are generally reducing their exposure.
Have you already seen a shift in terms of activity or in sentiment for real estate lending since the end of the U.S. election?
There’s a general optimism about tax reform coming through, making it easier to do business. But there’s also a pretty heavy dose of skepticism about what actually gets passed.
What was the takeaway from the failure of the Measure S ballot, which would have banned most development for two years?
It is a cautionary tale. Be prepared for land use by referendum. This one was defeated, but I’m sure there’s going to be another few that pop up. The takeaway is: Everyone’s watching here, so as we develop projects, we need to pay attention to who they impact and do a better job communicating.
Are you worried that the real estate market may be near a peak in L.A.?
How do you guard against the risk of a downturn? Whenever you get to the peak of anything, if you’re at Disneyland or Magic Mountain, you make sure you’re buckled up and safe. We’re definitely peaking in some of my markets, like my creative-office market on the Westside. But is that a new now or a peak? A peak assumes there’s a fall. I’m not smart enough to see the other side. I know that the demand for our spaces is good. The tenants we see have nice balance sheets.
CEO, Bank of the Ozarks
Do you think there are legitimate reasons to worry about a glut of luxury apartment buildings in downtown L.A. hitting the market at the same time?
There are some markets in the country where certainly you would be concerned about introducing more supply or financing more supply in those markets. The flip side is that there are a number of markets, including some of the submarkets in the Los Angeles area, where there really is a very healthy supply and demand and a genuine need for more product. A lot of developers have pulled back, which is healthy and reflects good business on developers’ part by not following through on projects that might have oversupplied the market.
We are a very low-leveraged lender. Our L.A.-area loans are 39.2 percent loan-to-cost and about 36.5 percent loan-to-value on average. We do very good projects that have really sound fundamental economics, and do them at very low leverage.
There’s a lot of talk about how tough lending conditions are in commercial real estate. Is that true?
Our leverage is a little bit lower than a year or two years ago, and that’s lower by far than what we were doing five or six years ago. There’s a natural conservatism given the fact that a lot of real estate has been created in a lot of markets. While I don’t think there’s a real problematic oversupply of most product in most markets, it is harder to find markets now that justify the creation of new products.
What types of developments in L.A. have the most difficulty securing financing? Why?
Hotels remain difficult to finance in that market. There are fewer lenders on hotels. To do that business, you’ve really got to build some expertise. We do a lot of hotel financing, but very cautiously and conservatively. But I don’t think the L.A. hotel market is particularly oversupplied. It’s certainly not overdone.
Does the Bank of the Ozarks offer nonrecourse construction loans?
All of our loans have various elements of recourse. We will, on every loan, carve out guarantees that basically control the borrower behavior and conduct. Yes, for the right project and the right market at the right leverage, nonrecourse financing is still available other than carve-out guarantees. Obviously, if there’s no repayment guarantee, we would want to be at a much lower leverage.
Managing principal, Lion Real Estate Group
How do you think the Trump administration will impact the environment for commercial real estate financing?
We believe more investors will move to invest in equities, which could cause a sell-off in the Treasury market and send interest rates higher. We all hope rental rates will continue to go up to offset the higher interest rates, but only time will tell.
Are you worried about a top in the L.A. real estate market?
I am not concerned with L.A. as a whole because we have a lack of housing.
What’s the biggest barrier in terms of securing financing to build in L.A.?
Land prices are very high and construction loans have lower leverage, which makes returns lower.
Greater L.A. market executive, Bank of America Merrill Lynch
How are banks changing their approach to commercial real estate lending today?
Construction lending continues to see pressures on rate and availability, both at Bank of America and with other lenders, because of the new way in which this product is viewed by the regulators. The result has been higher pricing across the board and banks being increasingly selective as to which clients will receive these funds.
Are there any types of development in L.A. that are especially facing trouble trying to secure financing?
Retail is an area for caution, given the seismic shift in buyer habits and the state of the retail industry. We expect this to continue to evolve into 2018.
Are downtown L.A. multifamily projects having a harder time getting financing now?
It has indeed gotten difficult to finance new construction in downtown L.A. at this point. The supply has mushroomed to more than 6,000 units actively under construction — most with top-of-the-market rents. The deals that are getting financed today all have significant cash equity and institutional sponsorship … This is a healthy governor on growth, hopefully resulting in a prolonged market cycle.
Are nonrecourse construction loans available from banks?
In general, banks require recourse for construction loans.
Are banks involved with lending to luxury condo developments in L.A. these days?
The primary lenders for developments of condominiums are small regional and foreign banks. I can’t speak for all banks, but we are not actively involved.
Have you already seen a shift in terms of demand or in sentiment for real estate lending since the U.S. election?
Not yet. The market is still digesting the information. I would say that the temperature right now is cautiously optimistic.
Senior vice president in the L.A. office of debt fund PCCP
Given the struggles of banks, what kind of opportunities do nonbank lenders have right now in L.A.?
The new dynamic is that the banks have tightened up on how much they will finance, stopping at 55 or 60 percent on most deals. This time three years ago, there were just two-thirds of the competitors that we have on the bridge lending market today. It’s a very competitive marketplace, especially for existing assets. If you’re a borrower, it’s a positive.
How much equity do you require developers to put into projects?
Even groups like ourselves are being more cautious. We generally range between 55 to 75 percent, leaving 25 to 35 percent of equity for the owners. We don’t typically play in the mezzanine space. We’ve seen those groups go up to 85 percent of cost, but that can range between 8 to 12 percent cost of capital.
In what parts of L.A. are you seeing the most opportunity right now? And what types of projects are you steering clear of?
Today, industrial and multifamily in Los Angeles are very attractive. Downtown it’s a little uncertain because there’s a lot of product being delivered. We would look more to areas in West Los Angeles, Hollywood, along the coast and in the South Bay area for multifamily and industrial. For industrial, which is very attractive right now, it even goes out to Inland Empire.
At this point, we would not look at financing condos, unless it’s a very special situation. In retail, you’ve got to be very selective because there’s obviously a very large dynamic shift going on. Malls are a no-go right now.
Executive vice president, Southern California at Kilroy Realty, a real estate investment trust
While Kilroy is a public company that doesn’t rely on financing for each project, in general has the financing market changed in L.A.?
Construction financing on any kind of speculative project is very difficult to get without the kind of guarantees that no developer wants to give. If you’re pre-leasing in L.A., financing is available. If you’re building on a speculative basis, there’s not much financing, if any, available.
How do you protect yourself in case the real estate market is heading toward a downturn?
We’re seeing consistent demand in all of our markets. But we’re certainly in the latter half of the business cycle. The key is not developing too much speculative product where you’re hanging out there. It’s important to be smart about how you stagger cash flows and layer in leases over a period of time.
Do you anticipate the Trump administration will help the real estate financing business by cutting back on financial regulation?
California is a highly regulated state. The biggest obstacle is the California Environmental Quality Act (CEQA), a well-intended law many years ago that has suffered a multitude of unintended consequences. Until that’s dealt with, it’s going to continue to hinder and be an albatross around developers, and a pricey one.
What is the lesson for the real estate industry from the Measure S referendum experience?
It’s a bullet that was dodged. Hopefully the lesson is to encourage counties to get their community plans and regulations in place so everyone understands the rules when they get going on a project.
Founder, California Landmark Group, a real estate development and investment company
What’s the biggest obstacle in terms of finding a suitable project in L.A.?
Sellers’ unrealistic expectations regarding their land values given entitlement risk, construction costs and flattening rents.
So do you worry that the red-hot L.A. real estate market may be nearing a peak? If so, how do you protect yourself?
Yes. We are very selective in what we purchase, and underwrite our deals assuming the economy will take a downturn.
Have you seen multifamily lenders demand more protection such as mezzanine lending or preferred equity structured so that they can take over if the project goes south?
Usually they simply want more equity, a buffer in case the world turns upside down.
Assistant vice president responsible for high-yield-debt originations in Southern California at Barings Real Estate Advisers, formerly known as Cornerstone
What’s the hardest part about finding attractive developments in L.A. to lend to?
Competition. Within the bridge debt space, there is a lot of competitive capital chasing a small number of attractive deals in the L.A. area. To win business, we are consistently seeing the winning lender offer more leverage than initially requested as well as having the tightest spread and most flexible structure.
What types of developments in L.A. are most attractive for lenders?
Due to Dodd-Frank and Basel III regulations, banks continue to have very stringent underwriting criteria for all new construction. That has resulted in relatively low leverage offered for senior construction loans. This allows the mezzanine lenders to generate very attractive returns despite conservative first-dollar and last-dollar attachment points. We have a preference for multifamily and industrial development at this moment.
Downtown L.A. has experienced a flood of supply of multifamily units. What does this say about the stage of the cycle? Are new projects having trouble getting financing?
Owners with attractive cost bases and sufficient liquidity to see out a potential supply glut should be fine over the long term, but the costs to build some of the more recent projects that are proposed, or still under construction, seem to be unsustainable if market conditions deteriorate.
Vice president for debt and structured finance, CBRE Capital Markets in Los Angeles
What types of existing developments have the easiest time securing financing?
We are seeing very strong lender demand for industrial projects located in Southern California, particularly projects that offer scale and diversification. Many lenders are underweighted on industrial and they like the fundamentals in SoCal given the low vacancy rates, strong rental appreciation and continued high tenant absorption trends.
How much mezzanine and senior debt is acceptable for commercial real estate projects in L.A. these days?
Generally, the senior construction lenders are requiring more equity now, and we typically see banks tap out at 50 to 60 percent loan-to-cost on construction loans today. Mezz structures can mitigate the amount of equity that developers need to supply, but the cost of capital goes up quickly as you go up the capital stack.
What about nonrecourse construction lending from banks? Has that tapered off?
The construction loan market has changed due to the regulatory environment facing banks as well as an air of caution at this point in the cycle … More banks are requiring a slice of recourse that can burn off as the project stabilizes, although there is still some nonrecourse construction loan money available.