As the residential development market bids the boom times in Manhattan goodbye, lenders are tightening their pocketbooks.
Gone are the days when a developer could typically bank on a lender to provide more than 80 percent of a condo project’s cost. With construction costs rising, lenders are also getting concerned about overruns. Many lenders, in fact, are now turning their attention to the red-hot hotel market — a market where climbing room rates have meant a cash-flow windfall for investors.
The Real Deal recently spoke with several leading professionals involved in arranging real estate financing in New York as well as one direct lender. Here’s what they had to say.
Steven Kohn
president and principal, Sonnenblick-Goldman
Q. What are lenders doing to deal with the slowing residential market?
A. They are not as aggressive on total loan proceeds as they were a year ago. Rather than lending 80 percent or above [of a project’s cost] they prefer 75 percent loan-to-cost. That is not to say that you can’t get a lender to go higher; there are just fewer players who will, and the pricing is higher. Lenders are also more sensitive to construction budgets since they have seen significant cost overruns and they are scrutinizing budgets more thoroughly than they have in the past.
Q. Are lenders shying away from condo projects now?
A. Some are, but there is still a sufficient group to review condo loans. The capital markets view New York positively; in Las Vegas or Florida the demand is more dependent on investors, but not in New York.
Q. All other things being equal for residential development, what is still attractive? Conversions or new construction? Which neighborhoods?
A. Conversions are attractive in that units can be delivered to market faster and the construction budget as a percentage of the total cost is less, so that lessens the risk of construction overruns. However, sometimes there are surprises when doing conversions, so that could lead to overruns. With a conversion the superstructure is already there, but in new construction there are new materials and it is generally superior. Some neighborhoods are more appropriate for conversions, such as Wall Street and Tribeca, whereas in Midtown, the Upper East Side, and Upper West Side, one tends to see both.
Q. What has happened to the first-time, novice developers? Are they still out there?
A. It’s gotten a little tougher for them. Lenders are more stringent than a year ago. They like to see a demonstrated track record. We have financed some [developers] that are less than optimal — that would be more for conversions and a smaller conversion at that.
Q. Are you seeing new condo projects get under way and get in trouble?
A. I haven’t seen or heard of any, though there are some that have experienced significant cost overruns. They could be in trouble if they don’t sell out a minimum number, but I don’t expect that.
Q. Are lenders becoming more interested in hotel and office projects? What’s the upside or the downside?
A. Lenders have been very aggressive on hotels and office properties. For a lender, they collect interest on loans; for the investor, the hotels’ upside is the cash flow has increased dramatically in the last couple of years versus office lease rates which are locked in for a term. Hotels are terrific, followed by multifamily properties that can capture rent increases frequently.
Q. Are lenders starting to require a rental backup plan if a project doesn’t work as a condo when it is built?
A. There is no official requirement; however, lenders assume the units will be rented if they cannot be sold. Condo prices are so high that it’s unlikely to happen. If rental rates continue to move up, though, as they are expected to, then some projects might work as rentals for developers. That is not the case for the super high-end. It depends on how much the developer is borrowing. If they borrow 75 to 80 percent [of the project’s cost] it’s less likely. In lower- to mid-price developments it could have a chance, especially if a developer borrows 65 to 70 percent.
Andrew Oliver
managing director and principal, Sonnenblick-Goldman
Q. What are lenders doing to deal with the slowing residential market? How are they being more conservative in their lending for new projects?
A. If a project is well-conceived and well-located, and it has a developer with good experience, there is still interest from lenders to do it. There has been a pullback in loan-to-cost in new construction from 80 percent to 75 percent. Mezzanine lenders [who supplement a primary loan with additional money] are being a little more cautious. Their position in the capital structure is they are not going up as high as they used to. It used to be 95 percent, now it’s down a little bit. With a mezzanine loan, you can still get 85 to 90 percent [of the total project cost].
Q. Are you seeing new condo projects get under way and get in trouble?
A. What you see is construction costs have gone up so much, so quickly. Since approval by the lender, sales prices have increased but construction prices have also increased, so they may have to go back and renegotiate with the lender to bring in mezzanine and/ or additional equity. But that’s to balance off the loans; it isn’t keeping the project from happening.
Q. How much real estate capital is out there now and is it changing as the market cools?
A. There is plenty of capital. It is shifting to other property types, but lenders still want to lend to real estate. It’s going to property acquisitions and hotel financing.
Q. Are banks still trying to get excess capital off their books?
A. Generally, some banks are getting paid off too quickly. They like to have the loans on their books. I have seen transactions where some lenders say to the borrower, “don’t pay us off so quickly. We will give you more of the proceeds from each sale so the loan is outstanding longer.”
Q. Are lenders becoming more interested in hotel and office projects? What’s the upside or the downside?
A. There is more money out there for office projects, but hotels have increased tremendously. The hotel market is so strong that some properties that would have been converted to condos are being kept as hotels. Hotels always have a higher risk with rate changes and nightly occupancy. If there was another September 11, they would still have to pay the rent even though their occupancy can drop to zero overnight.
Q. What sort of hotel projects are most attractive right now?
A. There is more interest in refinancing and acquisitions versus new construction. Hotels are being bought and turned around and some are bringing a new brand to the hotel. New construction is limited in four-and five-star hotels but that is good for the hotel market, too.
Richard Bassuk
president, the Singer and Bassuk Organization
Q. All other things being equal for residential development, what is attractive today?
A. Conversions are still very attractive to a lender. They start with an existing structure, the marketing is shorter, and construction time is shorter so they save on construction costs.
Q. How much real estate capital is out there now and is it changing as the market cools?
A. There are plenty of sources of this capital, but less than there were. If we’re doing a construction loan we go to 30 different institutions. We try to create competition. There are about 30 different players who will do a construction loan that will either lead it or participate in it.
Q. Are lenders becoming more interested in hotel and office projects? What’s the upside or the downside?
A. If the developer has a project that can work as a hotel in Manhattan, it can be financed. A project with a hotel below and a condo up above can augment the developer’s return and gives the lender confidence in it. No developer can finance a sizable office building on spec; they develop an office building where tenants are lined up in advance.
Q. What sort of hotel projects are most attractive right now?
A. Boutique or mixed-use, which, to get around the economics, are spreading some of the costs among other uses.
Q. What are least attractive?
A. The last big hotel project was at the Time Warner Center, which has a very high room rate, in excess of $1,000 a night.
Q. What is the outlook with rising interest rates?
A. They are not going to be helpful but they are not a factor that will make or break a project. More than 200 basis points, then it would start to be a factor. Years ago, 7.5 percent would be a bonanza; today, it’s below that, nothing is changed.
Q. What is the outlook for rental development?
A. This year maybe 1,500 rental units will come to the market, which is 20 to 25 percent of what it was two or three years ago. The lack of supply in rental housing will drive up rents to where it will become feasible eventually. Three years ago, I did a rental project where the land cost per square foot was $100. Today, in the same location, I just did another project and now the land is $350 a square foot. Construction costs three years ago were $175 a square foot. Today it’s $400. In that time rents have gone up no more than 20 percent. Three years ago, 75 percent of my financing was rental, 25 percent condo; today it is 90 percent condo, 10 percent rental.
Q. What is the typical point of no return for a project?
A. Once you’ve closed the construction loan and the bank starts advancing, you have to start and finish the project. The guarantee is that you have to finish it. In New York, there is no one that does not require a guarantee.
James Houlihan
partner, Houlihan-Parnes/iCap Realty Advisors
Q. What are lenders doing to deal with the slowing residential market?
A. With condo conversions and condo construction they are more cautious than in the recent past, with some new proposed deals put on hold and others that may not go forward. Some lenders have said they don’t want to do more at the moment or they only want people with a proven track record. It is tougher to finance than a year ago and more complicated and much more difficult for novices.
Q. Are banks still trying to get excess capital off their books?
A. There is an added level of difficulty in getting money out the door, and they are forced to compete aggressively for a limited amount of product. There is strong investment in real estate after the implosion of the dot-coms and company scandals so there is still plenty of money on the equity side.
Jeffrey Wolfer
president, Kennedy Funding
Q. What sort of projects are most attractive right now?
A. We will do anything that is asset-based and 90 percent is real estate secured. If the bank says no, then we’ll say yes. Any real estate secured loan for office, land, residential, any type of loan — we are interested in secured. I believe Manhattan will pull back just like other places.
Q. What has happened to the first-time, novice developers? Are they still out there?
A. They are the ones out there that are now buying land from previous owners, thinking, “Wait, I can get into this and make money.” It’s always the novice that gets in last. Experienced developers can have the last laugh; the novices are the ones that will be stuck with a development that’s not going to sell. That’s what is going to happen. It was a seller’s market a year ago and it’s a buyer’s market now.
Q. Are developers more or less likely to take on mezzanine debt now?
A. They are more likely. Mezzanine lenders have to start being worried, because if the real estate market pulls back 20 percent, which is not that much, the mezzanine and developer will have lost their money. The appreciation of the real estate market has made the mezzanine lenders look like geniuses. If it became stagnant, the mezzanine market would be tested and it would be very interesting to see what happens.
Michael Sonnabend
principal, AFC Realty Capital
Q. Are lenders shying away from condo projects now?
A. In New York it’s still attractive; they like to invest in New York. Lenders look at New York as a little different from other parts of the country, especially because of the constraints on supply. But they are now making sure the project works at where prices are today, as opposed to it only being a good deal if prices go up.
Q. All other things being equal for residential development, which neighborhoods are most attractive?
A. It’s mostly just making sure that the deal works at a sales price that people are comfortable with. We’ve just had condo deals at very different prices; one on the West Side at $1,500 square foot and one in Harlem that came out to $700 square foot.
Q. How much are lenders providing for residential projects?
A. For most projects the primary loan is 75 to 80 percent. We just closed a deal on the West Side that was financed at 95 percent, including the mezzanine loan. They had to write a check to cover the rest. They could have raised equity, but they didn’t want to do that.
Q. Are lenders becoming more interested in hotel and office projects? What’s the upside or the downside?
A. We have been doing a lot of hotels. You need a lender who understands the business, especially on a hotel. Getting a loan with a lender that doesn’t understand hotels can be a problem down the road.
Q. Do you think there will be more office development soon?
A. There will be some people renovating older buildings in a good location, like the Verizon building on 42nd Street and Sixth Avenue.
Dan Cooperman
director, the Greenwich Group
Q. What are lenders doing to deal with the slowing residential market?
A. In New York, lenders are more cautious, but in all the markets in the states, they are least cautious in New York. The condo market in New York performs better than anywhere else. In the city, lenders are more cautious in places like the Lower East Side rather than the Upper West Side, and are paying closer attention to fringe locations. The fringe areas could see a large drop in sales price per foot.
Q. All other things being equal for residential development, which neighborhoods are the most attractive?
A. The markets that are the strongest in the city are the Upper West Side, the West Village, and Tribeca. On the Upper East Side, there’s a lot of inventory but you don’t have the same dynamics as the Upper West Side.
Q. What sort of hotel projects are most attractive right now?
A. Any hotel is attractive if it has a good operator and reservation system. In the Meatpacking District, it is a boutique hotel hotbed. The Gansevoort and the Maritime hotels, for example, attract younger affluent people who want a hotel that they can party at. There are a handful of chic and pioneering hotels which are now the hippest of the hip. Limited service, boutique, high-end — they are all doing well, throughout Manhattan.
Q. Do you think there will be more office development soon?
A. Several million square feet of new development is or will be finished in the next few years, but it cannot be done on a speculative basis. Given the cost of construction and land, it is difficult to pencil out a deal that makes financial sense. Residential can build at a higher cost, but it can sell for a lot more.
Mark Cohen
senior director, L.J. Melody & Company
Q. Are lenders shying away from condo projects now?
A. Some lenders are definitely shying away from condos. They feel the market is overheated and they made a lot of condo loans so that they have a full plate. Until they get those paid back they are not looking for more. The reality is that it is also somewhat of an excuse. It plays into their feeling that the condo market is getting a little dicey and they would like to cut back on their expenses.
Q. All other things being equal for residential development, what are the most attractive neighborhoods?
A. Tribeca and the other Downtown neighborhoods like the Meatpacking District and Soho. I haven’t seen the market go cold, frankly. There is still a strong housing market; therefore, good projects will come out of the ground in reasonable locations. Developers are building into a future that is always uncertain because what it is worth today may not mean anything because you aren’t marketing it for two years.
Q. What sort of hotel projects are most attractive right now?
A. The most desirable hotel projects are those that have major sponsors, one that is a partner in the deal, like if Marriott teamed up with Tishman Speyer, for instance. High-end boutique and budget hotels are in demand. Budget hotels are greatly needed in New York and lenders love to finance them. They were out of fashion and now they are in.
Q. What sort of office projects are most attractive right now?
A. Office projects are definitely a hot commodity. If it’s pre-leased to a major corporation, it’s shrunk most of the risk out of the deal. If it’s speculative and it’s the right deal with the right developer, it can be financed.
Q. Do you think there will be more office development soon?
A. Yes. Those areas that have the least amount of space available like Midtown or the Sixth Avenue corridor, you’ll see more development.
Q. Are developers more or less likely to take on mezzanine debt?
A. As the banks clamp down and lend less on a project, developers will need to get more mezzanine debt. Some of these condo projects right now might only get 60 to 65 percent, depending on the developer. The second- and third-tier developers who used to get 80 percent are lucky to get 70 percent.