Let the Good Times Roll . . .

This is an HTML version of a story that ran in the April issue of Real Estate Forum. To see the article in its original format, click here.

Melissa Pielet, executive vice president of finance for Chicago-based HSA Commercial, well remembers the time she walked out of a closing, paperwork left behind unsigned. After all, it wasn't that long ago and, as happenstance would have it, Pielet was preparing to go to a closing with a new lender offering better terms than the first one when Real Estate Forum caught up with her.

The original lender was a CMBS provider and the property was a multi-tenant industrial complex in the Midwest. At the closing, Pielet was taken aback by several clauses that weren't favorable to her client. For example, the lender claimed the right to sweep cash should the building lose a tenant—even if the property was still cash flowing.

Pielet wasn't happy—and she knew there were other options. So she walked. Within weeks she was able to arrange financing with an Indiana-based bank. It is a 10-year term, Pielet says, with very straightforward requirements.

“Just what do borrowers want these days?” one can almost hear Pielet's abandoned CMBS provider plaintively asking. Five years ago, the world was just about coming to an end. Now the CMBS market has restarted, banks have opened their doors and balance sheets again to the commercial real estate community and life companies are stepping up their CRE allocations. What more could borrowers want?

As it happens, a lot more.

Let's leave aside the usual wish list of high loan-to-value leverage, no recourse, low interest rates and loose underwriting. Those are a given. One common desire by borrowers, found across markets and asset classes, is to see lenders continue their push to blur product lines and in general be as flexible as possible. For some borrowers—namely those in troubled markets—this wish translates into hoping for a lender that is willing to underwrite a property that is 65% occupied instead of insisting on a by-the-books number of 70% occupancy.

For other borrowers in better-positioned markets, though, the sky is becoming the limit. They want the basement-bottom rates of banks, the scale of CMBS and the competitive tension between the GSEs and life companies—all rolled into one Lady Bountiful-like lender.

They are hardly there yet, but interestingly, five years out from the crash and Great Recession, they are a lot closer than the market ever would have imagined.

Pielet, for instance, is practically writing her own ticket, or rather loan documents, these days. Certainly her schedule is full, running from one closing to another. Recently, she organized financing for two regional shopping malls. One was with Key Bank to arrange acquisition financing for the Lakeview Square Mall in Battle Creek, MI, a 559,000-square-foot shopping mall anchored by Macy's, Sears, and JC Penney. Then Pielet refinanced the Holiday Village Mall in Great Falls, MT by obtaining $36 million in CMBS debt for the property.

Spec industrial, though, is where the real action is. “Right now I'm having the easiest time doing spec industrial deals,” she says. “There was a lack of building in the past few years and vacancy has dramatically dropped.”

At the same time, she continues, lenders are having a hard time finding quality institutional-grade industrial products and they are looking for new construction—which in Chicago tends to be spec.

The best providers, in her experience, are the banks, something that was not always the case. “We are seeing a lot of term loans with banks right now,” she says—five, seven and 10-year loans depending on credit and leverage and recourse.

In the past, Pielet would frequently turn to CMBS and life for such transactions. “I never used to use banks for anything other than bridge and construction finance—now I'm using them for permanent financing.”

“We've also started doing more permanent financing with local banks,” she continues. Many of these institutions, she says, have put balance sheet programs in place to make longer-term money available.

Pielet has done perhaps two or three CMBS deals and two life deals in the past year, but that's nothing compared to her previous track record when she was the top local producer for a major life company. “With bank financing, you have carte blanche in terms of creativity, as long as it doesn't hurt the bank,” Pielet says.

Not that Pielet has sworn off CMBS lending altogether. One deal she did with a CMBS lender financed a large regional mall in Montana in which the lender gave the borrower the ability to raise additional capital and prepay an existing mezz piece. “Some projects are tailor-made for CMBS.”

Indeed, it is a misnomer to use the term “lender” so generically, even in the best markets. The various players—banks, life companies, CMBS, structured finance, GSEs and even the government—have their pros and cons and it is the savvy borrower that's able to pick which of the options is best suited to his or her particular needs.

For example, right now banks are generally providing inexpensive short-term money, perfect for acquisitions or construction. So if a borrower wants cheap rates most of all, he'll go to the banks. However, again generally speaking, this money is being offered at a lower yield level than the cycle of 2006-07.

Life companies, like the banks, have become more aggressive but they tend to take a longer view on lending and they also tend to work mainly with institutional clients. In this environment, their floor appears to be the 75 to 80% LTV range.

But how many of these choices are actually available to a borrower depends entirely on the market. This has always been true, of course—but it is easy to overlook when stories of aggressive and hungry banks start making the rounds.

Andy Farbman, CEO of Farbman Group, which is based in Detroit, has his own share of “I can't believe how good it's gotten” war stories about commercial real estate lenders: He tells of one property he's refinancing now that he first took to the markets a year ago. Then it was a distressed property and Farbman assumed he would have to borrow in the short-term markets. Instead, “we were surprised that the life companies were as aggressive as they were. We wound up with a loan of 80% LTV, which we never thought we would get. In fact we figured that is what the next borrower's capital would look like—but not ours.

“Now, it's a year later and we're wishing we'd gone to the short-term markets as we originally thought we would have to because the asset's value is so much higher,” he continues. The firm recently decided it would be worthwhile to refinance even though the loan has been in place for only a year. “Financing is definitely back—in a big way.”

In short, Pielet and Farbman are able to speak for what is happening in their markets and only their markets. They are, admittedly, among the lucky ones for this particular cycle.

A look further afield will find varying—sometimes significantly—experiences with the lending community. For these companies, the question “what do borrowers want” becomes a matter of just the basics. “I want my lender to give serious consideration to my property even though we have lost tenants.” “I want my lender to offer non-recourse financing.” “I want my lender to pick up the phone, darn it!” will be among the rhetorical answers.

Lenders still know how to say no to deals they deem to be too risky, as Stephen Hagenbuckle can well attest.

Hagenbuckle is founder of Fort Myers, FL-based real estate private equity firm TerraCap Partners, which invests primarily in distressed real estate in the South. The properties he buys are usually 30% to 60% occupied—a level that even the hungriest of lenders are unwilling to touch. “Yes, lenders still have their underwriting standards, I see it all the time,” Hagenbuckle says.

TerraCap buys these properties in cash, stabilizes them to north of 70%. It's at that point the lenders enter the picture, sometimes, depending on the asset, very aggressively. “When the property is stable, they'll pursue it vigorously,” Hagenbuckle says.

The reason, in his view, is that lenders haven't relaxed their underwriting per se, but more lenders are coming back on line and pursuing fewer deals. “Prior to that, they are reluctant to even talk to you. Underwriting is still strict; don't let anyone tell you otherwise.”

One can see that in shaky properties coming up for renewal. If the occupancy or rent roll has dipped below stabilized levels, lenders will typically ask for a principal paydown to provide cross collateralization, he says.

That all said, borrowers are gaining leverage—and not in the strict real estate definition—on borrowers, Hagenbuckle concludes. “The second we get a property up to 70% occupancy, the lenders are all over us. That definitely wasn't the case a year ago.”

Another moderate view of the lending environment comes from John Maheras, a partner in a law firm and state director of the International Council of Shopping Centers for North Carolina and South Carolina.

One of his goals for his term, which starts in May, is to help members locate additional financing options for tenants. Too many, he says, try to get financing for a portion of the upfit work and find they can't get qualified through their lenders. That is a key reason why deals are taking longer to go through, he says.

The burden is falling disproportionately on smaller retail tenants, which don't have the heft or cache to inspire the retailers to be more forthcoming in financing the deal and can't get a loan from a local bank.

In a way, though, Maheras can't blame the retailers, which are struggling with their own cost and financing issues. “We are seeing lenders become more restrictive on underwriting issues for acquisitions. In 2007, a retailer could put down 5% to 10% for an acquisition but in today's market it must be 25%.” Yes, he concludes, lenders are more flexible now, but they are still closely scrutinizing credit profiles.

Dick Bryant, principal in Lee & Associates' Atlanta office, reports a similar mixed landscape. Borrowers in Atlanta are getting deals done through a grab bag of sources ranging from the US Small Business Administration to Bank of America.

“There is still a very wide trough between class A and class C properties—that is, between stabilized, well-leased buildings and value-add properties,” he says.

And as for troubled assets, lending is downright scarce, Bryant says. “Mostly those transactions are trading through all cash or possibly a small loan.”

He also gives a familiar refrain about the lending market: “once you get the asset stabilized, the lenders will come calling.”

Unfortunately in the Atlanta market there is little shortage of industrial and office buildings that are vacant or under utilized. For these properties Bryant has seen an uptick in SBA financing. “We have done five or six of those this year alone.”

He is also seeing a resurgence of lending from small community banks, especially compared to the large money center banks. “It is just how the market is now—the smaller community banks are more likely to make loans than the larger banks.” Bryant reports he recently represented a borrower that approached eight community banks and four national ones. None of the national banks were interested in the deal. The borrower eventually secured a loan at 80% LTV at a rate between 5.5% and 6%.

CMBS is also active in the Atlanta market and in rare cases some of these institutions are willing to go as low as $2 million in their loans, Bryant reports. “But they are primarily interested in multifamily and grocery-anchored shopping centers.”

Several hundred miles south Bryant's colleague is finding the lending even more inhospitable. “Lending is very tight here; of all the deals I have done in the last 18 months, I would say 90% have been all cash,” says Jerry Messonnier, principal at Lee & Associates in Naples, FL.

The reason is simple—lenders are only lending based on cash flow right now.

“Every building in our market has some kind of a vacancy issue,” he says. “Our market took some significant hits in rental rates, 40% to 80% drops and commensurate drops in valuations.”

The banks don't necessarily care about the appraisals—or just the appraisals—but they are manic about cash flow. “For us, it is not about equity at all anymore; cash flow is all that banks care about.”

It's frustrating to borrowers that have a significant chunk of equity in a building and know that the property will increase in value, but are having short-term cash or vacancy issues, he says. “But banks are turning their backs on any deals with those qualities.”