Michelle Napoli is editor of TIC Monthly, from which this article is excerpted.

Houston—Frank Satterfield, principal of Houston-based mortgage banker Harbor Capital Group, has been working with a TIC sponsor pricing debt for a class B apartment deal. On a recent Friday, a lender quoted the sponsor a loan at 140 basis points over the 10-year Treasury. The rate was not locked, and by the following Monday, the lender's spread jumped to 200 basis points--a significant increase over the course of essentially one business day. That left the sponsor wondering whether it should try to extend its closing date in the hopes the capital markets will settle down or re-price its TIC deal, Satterfield explains.

Such is the uncertainty in the volatile debt market, a market that has many lenders and borrowers of all types in limbo as financing costs rise, rate locks in some cases are not honored and interest-only periods are increasingly hard to find. TIC sponsors are not immune, and some fear the state of the debt financing market will have a detrimental impact on deal flow and volume in the TIC market for the rest of the year.

"For a couple of weeks, it's been pretty hectic," says Satterfield. "Now nobody's holding a spread for any length of time, and deals are falling out left and right."

The CMBS market--where most TIC sponsors find their debt financing--began to tighten some this past spring. That's when New York City-based ratings agency Moody's Investors Service announced it would implement increased subordination for certain classes of the securities in its review of CMBS transactions, "in response to a trend of declining credit quality," as Moody's explained. At the same time, concerns about the subprime residential mortgage market first began to surface--concerns that have since been borne out in what can easily be described as a meltdown affecting all corners of the bond and credit markets.

On top of the current shortage of bond buyers and uncertainty in pricing, there is a flood of new CMBS offerings waiting for securitization. Eric Tupler, managing director in the Denver office of CBRE|Melody, says, based on data he's seen, there is between $50 billion and $60 billion of supply currently waiting for securitization, whereas a normal pipeline might be $30 billion to $40 billion. "And there's more that's been originated that needs to come to market," says Tupler. "Until that supply gets absorbed, we don't know what the market price is for that paper." Even if the market were to normalize today, he adds, it would take time to sell off what has accumulated due to the lack of liquidity.

While lenders and borrowers are still actively in the market, the fact is many have run to the sidelines given the uncertainty. Life companies, which are in a good position to regain some market share from the CMBS world, have also revamped their underwriting and pricing, says Tupler, and will be cherry picking deals. But even if they are busier than they've been in the past several years, Tupler says it is of little help to TIC sponsors, since the life company lenders have, by and large, not been willing to lend on their deals. Satterfield, though, says he will make more of a point to put TIC deals in front of life companies, since they may now be more competitive in pricing and since they could, at least theoretically, become a bigger force in lending to TIC sponsors in coming months.

Not having any control over debt pricing until funding occurs is not easy for any property buyer, but could be especially difficult for TIC sponsors who need to know what kind of yields they can market to potential investors, and who don't want to find themselves with product sitting on the market that won't sell because the yield is too low. "It is very much a tenuous situation. It's almost a standstill to some extent," says Tupler, who works with many TIC sponsors. "We're seeing a lot of them move to the sidelines, but we're also seeing them work to figure out an opportunity."

Charles "Duke" Runnels, president and CEO of Los Angeles-based Fort Properties Inc., says three properties his company recently closed on would likely not happen today, given that the cost of funds would be about 50 basis points more than it was. Though he expects there may be a bit of slowdown in deal volume in the immediate future, Fort Properties is not taking a breather and is currently looking at new properties. "We're still actively in the market," he says.

But that may not be the case for all TIC sponsors. Daniel Oschin, EVP and director of real estate services for Calabasas, CA-based AFA Financial Group LLC, says he knows of one sponsor that "in the last week or two have just let their deals go," and that some sponsors are simply not looking at any new deals for now. He adds that if the current debt market volatility "lasts for any extended period of time," the TIC market will see a real slowdown in the amount of deals offered, and says that could be especially troublesome for sponsors that are not diversified with other product offerings. Likewise, he said a slowdown in sales on the downleg portion of 1031 exchanges could mean less equity coming to the TIC market. "It depends on how long this lasts," he says.

Some express concerns the pricier debt could lead to less quality deals in the TIC marketplace, such as more deals from tertiary markets that can still be sold at attractive cash-on-cash returns, despite the increase in debt costs. Oschin worries the current situation could lead to reps selling product they shouldn't and to sponsors pursuing deals they shouldn't, such as riskier property types and deals with unrealistic yields and/or poor underwriting. He says he is already seeing sponsors structuring in deferred management fees, using bow-tie loans and reserving for expenses like property taxes out of equity instead of pro forma, as examples, all in the name of boosting initial yields. "How much risk can you put on a deal before you stress it too much?" he asks.

It is unclear, of course, just how long the current debt market crisis might last, or how much more CMBS spreads might widen. But Tupler, for one, thinks the situation could very well go into the fourth quarter. And some expect spreads could go as high as 225, even 250, basis points soon enough.

In the longer term, though, many agree that what is taking place in the debt market may ultimately lead to a welcome correction to what has been too-loose debt underwriting standards and to the tough pricing and cap rates that have characterized the commercial property market for some time. Though there will be some lag time, costlier debt should lead to an adjustment in sellers' expectations and an upward adjustment in cap rates, which would ultimately have a positive effect for TIC sponsors, who would find it easier to buy properties with decent cash flow.

But for now, uncertainty reigns. "The market is changing every day," notes Runnels. "Three's no liquidity in the market, there's no stability in the market, and it's hard for people to make plans not knowing what the future will be."

Instant Insights /

Volatile Debt Market Stalling Deals

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