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We recently solicited financing for a “distressed” multi-family acquisition, and here share a few salient points about what capital sources are demanding in the new-paradigm for debt and equity. The deal was much like the hundreds of other financings we’ve struggled (and often failed) to consummate over the past two years.

However, it had all the right characteristics – great sponsorship, solid real estate in a rebounding rental market, and a distressed trade at a significant discount to replacement cost. Therefore financing was isolated as the primary hurdle to closing, and our pursuit revealed interesting points about capital market idiosyncrasies – this month. Ultimately, we are encouraged that, (provided the last 4-5 months of relative stability persist), we’re increasingly able to predict attitudes and locate able sources; sooner than later that will translate into closings.

Liquidity Exists

First, let it be known that liquidity does exist. The capital markets are evolving rapidly, with players entering and exiting weekly. The market is highly inefficient, and locating capital demands a lot of ground work. Those with real capacity and discretion are few and far between; most are only pretending to be active to protect their brand. But the truth is revealed when the best opportunities are presented – and excuses are eliminated. In this way, the real players are starting to surface. A select group of lenders and institutional equity investors do indeed have capital; what’s more, they want to deploy it.

However, capital has almost universally been out of the game for 12-24 months, and it is very cautious about re-entry; the first deal in 12-18 months is going to have to be nearly perfect. Capital has to be compelled in order to overcome endemic stand-still inertia.

Economic Underwriting

It goes without saying that the underwriting treatment for both debt and equity is radically more conservative today. We’ve all seen deals killed by conservative assumptions. For example, we recently note:

Rents marked down to a very conservative estimate of “market” rent;

Conservative underwriting adjustments for total cost of occupancy, considering RUBS, NNN expenses, capital costs, etc.;

Vacancy underwritten at the higher of 10% or actual-market (rather than the traditional 5%), with careful attention to direct versus sublet space, economic versus physical occupancy, and concessions;

Conservative allowances for re-tenanting in terms of cost and absorption rate; and

Draconian exit cap-rate assumptions.

Compelling Opportunities

In additional to these types of baseline economic hurdles, and inertia holding the investor at a stand-still, the successful deal will be “compelling”. This includes:

Best-in-class sponsorship with a long track record of success in the specific subject market and product type;

Making money on the “buy”, where the dollar-per-pound project costs represent a significant discount to replacement cost; and

Safe foundation of cash-flow, where a conservative estimate of stabilized NOI over costs is higher than a reasonable exit cap-rate assumption.


In addition to being compelled, capital also demands supplementary risk-mitigation measures to satisfy extreme risk-aversion, such as:

Conservative business plans, including the capacity, investment horizon and debt term to safely “carry” the project in a down-side scenario for 5 years;

Underwriting sponsor liquidity to solve problems, exposure to maturities in their existing portfolio, and legacy portfolio risks;

Carefully considering the availability of capital to support the exit, and investing only where they can confidently predict a take-out financing or buyer liquidity;

Selecting stable or recovering markets, or building in a significant cushion for further deterioration.

Debt / Equity Appetite Disparity

Consistent with the market’s general aversion to risk, we’re seeing a distinct disparity between debt and equity relative to their appetite to transact. While there’s probably greater relative liquidity in equity than debt, institutional investors are more cautious and slower than lenders to make decisions because their investment tranche is most risk-exposed. Lenders are prepared to act more assertively because they feel safe at the bottom of a conservative capital stack. Where we find 2-3 willing and able lenders, we’ll struggle to move equity sources.

Caution Over Speed

What’s more, capital won’t be rushed. Decisions are made by committee. In the good-old-days, a well connected intermediary could make “the call” for a quick thumbs-up / thumbs-down from the key decision maker, with 80-90% accuracy. Today, a diverse panel of stake-holders is consulted. Diligence is thorough. The fact set must be complete. All eventualities must be considered. Risks must be defined and mitigated. The deal should expect to wait for the money.

This reality is frustrating, because the “perfect deal”, by definition, is “distressed” and therefore trading on a short fuse. So what’s a deal-maker to do? Prepare.

Build Relationships with Capital

The one constant feature of any deal you are going to pursue is yourself. Conveniently, you are also the single most important consideration for any potential capital partner. Your sponsorship is of paramount importance. So why not address that risk now, before the deal arrives?

We’re working to match capable sources with capable users, asking our investors and lenders to underwrite our clients as sponsors – before a specific deal is identified. As you might imagine, launching such an undertaking requires some convincing – only the most compelling applicants warrant this kind of investment from busy institutions. The real players are very busy, while the “pretenders” have time to spare. But everyone appreciates the looming opportunities and associated “short-fuse” closings required to exploit them.

Our process starts with introducing principals and building personal relationships, then proceeds to detailed diligence of performance history, financial capacity, and portfolio/legacy risks, and ultimately concludes with a pre-negotiated “shelf-agreement” – defining an agreed structure and strike-plate. Thus, the sponsor is armed for the hunt. And the most time consuming component of due diligence is completed before the clock starts, leaving only asset specific risk analysis between you and closing.


We don’t expect commercial real estate transactional volume to abruptly spike any time soon. However the recent crisis will ultimately drive the largest transfer of wealth in a generation. Phenomenal investments are beginning to materialize. When they do, the window of opportunity is brief. The well prepared sponsor with capital and connections will reap the benefits.

Steve Orchard, a vice president, and Gary Mozer, a principal, are both with investment firm George Smith Partners, based in Los Angeles. Opinions are the authors’ own.

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