Capital Is Flooding to the ‘Right’ Office Deals

Capital is flooding to office deals in Orange County. Demand is strong for the “right deals,” says Kevin MacKenzie, executive managing director at HFF, but the deals getting done are a mixed bag, ranging from sub $50 million requests to capital-intensive deals. MacKenzie recently secured $144 million for a four-building office asset in Orange County, along with his HFF colleagues senior director John Chun, director Jamie Kline, and associate Peter Thompson. The three-year, floating rate deal was funded through New York Life Insurance. We sat down with MacKenzie to talk about the capital markets trends for Orange County office and get his advice for borrowers looking to take advantage of the capital dynamics.

GlobeSt.com: What is lender demand like for traditional office product in Orange County?

Kevin MacKenzie: Lender demand is strong for the right office product in Orange County, with an abundance of capital options available across the risk spectrum. In the last 12 months we have been involved in the financing of several larger scale transactions such as The Bridges, The Press, Flight, and most recently Intersect. While those type of transactions tend to attract significant capital, we have also seen high demand for sub $50 million requests as well.  These projects range from vacant buildings or development to fully stabilized assets, and in nearly all cases there has been efficient capital readily available with aggressive outliers typically being identified through the marketing process.

GlobeSt.com: How did this sponsor in this deal take advantage of current capital dynamics?

MacKenzie: The bridge market has continued to become more aggressive the past 12 months, with a significant amount of dry powder available in the debt funds, plus many banks, life companies, and advisors having programs that can be competitive. As sponsors are able to get mid-way through their business plan on value-add assets there is typically debt available that will provide some element of cash out at a lower cost of capital. The combination of spread compression in this space, along with some level of leasing activity on projects partially through the business plan, can often lead to spread reductions of 100 basis points or more from the original loans placed as little as one to two years ago. Re-financing at this stage also effectively allows a sponsor to extend term early, and continue to work through their business plan while enjoying additional cash flow from the asset to increase returns over the hold period.

GlobeSt.com: What is your advice to sponsors looking to secure financing of office product in Orange County today?

MacKenzie: Borrowers need make sure they understand the number of options available today, and underwrite scenarios across the capital stack to achieve the most efficient cost of capital for the project.  Several years ago we had a barbell in pricing and leverage between banks and debt funds with not much in between. With the wide variety of capital available in the market today, and different programs being added frequently, we often price deals in increments between 55% and 75% loan-to-value in order to determine the sweet spot in the capital stack. In one recent example, on a portfolio with a light value add element, we started out at 65% LTV around 250 bps over LIBOR, and ended up compressing spreads over 100 bps before the ultimate lender was selected at sub 150 over and north of 65% LTV. The competition, amongst other factors, has created significant spread compression in the bridge space and we often see a wide variety of lenders types all competing with each other across the capital spectrum. The barbell is gone but you have to fully understand the market in real time.

GlobeSt.com: How will rising interest rates impact lending activity in this market?

MacKenzie: If you look back historically, rising interest rates do not typically result in less lending activity, as the drivers behind rates increasing generally correlate with strong property performance in terms of rising rents, leasing activity, etc.  The more important factor is availability of capital, so as long as that remains at all-time highs, we would expect to continue to see significant activity.  In fact, during the past 6 months while we have experienced significant increases in the underlying indexes (Treasury rates and LIBOR), we have continued to see elevated levels of re-finance activity. This is a result of clients analyzing options to get ahead of debt maturities, and extend term while rates remain historically low and debt markets highly liquid. The yield curve has also flattened significantly which has led to sponsors more closely evaluating long term vs. short-term debt, and fixed vs. floating.

GlobeSt.com: What is your outlook for lender appetite for office product in Orange County this year, and why?

MacKenzie: Assuming fundamentals remain strong, then we should continue to see debt capital attracted to Orange County, especially for the right projects and best in class sponsors.