COVER STORY, APRIL 2008

BACK TO THE BASICS
Securing financing in today’s investment sales market.
Andrew Benioff

Benioff

Now is the time to focus on the basics — strategy, experience, and realistic returns

It’s hard to believe it was little over a year ago that Blackstone acquired Equity Office for $39 billion. That deal signified not only the height of the commercial real estate boom, but also its end. Now, (to put it mildly), credit is a bit harder to come by.

But hard as it is, deals are still being done and commercial real estate is still considered a solid investment. However, now more than ever, owners need to get back to the basics when sourcing capital. Before you begin negotiating that next deal, take a moment to refresh yourself on the basics of what lenders want.

Strategy First, Financing Second

As both a bridge debt lender and a financial intermediary with nearly 20 years experience in real estate investment and operations, I’ve helped clients secure financing for all types of properties. Whether these clients were just starting out or highly experienced, the secret to success was always the same… each owner was able to articulate the story of the property in clear and concise terms. They discussed the who, what, where, when, and why before they even began to talk numbers. And they stayed realistic, objective and positive, even when the property in question was highly distressed. No matter what the situation, they led the deal; the deal didn’t lead them.

Therefore, the first basic step in securing capital is having a clear and defined strategy for the property. Lenders want to know that you have a vision with specific, actionable steps. For renovations, they want to know what will be done, who will do it, and how it will affect rents or rates. For new construction, they want to see all of these things plus information regarding zoning, entitlements, and other possible barriers. And most importantly, they want to know when you will finance it out (on the debt side) or when investors can expect positive cash flow/returns (on the equity side). Being able to articulate the property’s past, present, and future — and the steps you will take to get results — is paramount.

An important part of this strategy is your team. Lenders want to know that the people they are lending to have direct and successful experience with the same type and size of property that you now propose. A few years ago, they may have overlooked the fact that an industrial owner was venturing into hospitality or vice versa, but today it’s all about proven performance in the same sector. Often, I tell my clients to start small when venturing into a different property type. Showing good returns on a small hotel renovation may be all it takes to get to the next level. Another solution is to bring on collaborators with the relevant experience.

Another strategy question you must answer is “why now?” Today, prices have yet to drop but they will. Your investor may want to wait and you need to convey to them why it’s now or never. This is one of the hardest things to articulate, but it’s also very important. You never want your investor to think you want the deal simply because it’s there. Timing must be an integral part of your strategy.

Of course, the last, and most important piece of your story is the “ending” — your exit strategy.  The lender needs to know how and when the borrower will repay the loan. This payoff could be from a refinance, a sale, or full amortization of the loan.

Think Conservative Underwriting (Really!)

Many owners think they are being realistic about underwriting when they are, quite frankly, nowhere close. When I say conservative, I mean really conservative. Just recently, I was approached to find financing for a “great deal” that promised 30 percent in returns. Once we took apart the budget and pro forma and put it back together, the real number was 12 percent. 

Inflated numbers are a result of the recent market surge mixed with an owner’s natural tendency to be optimistic and assume their property will perform at or above market value. (It’s also partly because anyone can make a property look profitable on paper.) Let’s remember, in a down market, most properties will show below-average performance. So considering this — and the state of the economy at large — it is best to be as conservative as possible with underwriting. And where 20 to 30 percent returns may have seemed commonplace in 2006 and 2007, in today’s market, investors are trading these higher returns for reduced risk.

Know Your Lenders

Lenders appetites for various asset classes change weekly, depending on their own portfolio-management needs. For example, a current high demand for full-service hotels might be perceived as a popular endeavor that will last. But in reality, market research suggests the lending trend is transient. Borrowers must be aware of what is hot, what is selling and what the lending market desires.

Borrowers also need to understand each lender’s parameters. A lender that 2 years ago may have strayed from their primary real estate category probably won’t do so today. And, in general, lenders are tightening their criteria to be more specific, so be sure to understand there preferences or you are wasting your time.

Be Realistic About Leverage

Lastly, owners need to stay realistic about the amount of leverage they have. Since just last year, the amount of debt you can put on any property has changed drastically. Gone are the days of financing in the 80 to 95 percent range for first position debt. Today, the amount you can finance is in the 65 to 75 percent range.

There are still some community banks and private lending institutions that are willing to go as high as 80 percent, but it is very expensive, and getting harder and harder to find. The new reality for the vast majority of deals is 70 percent for first mortgage loans. You can still put mezzanine debt on top of that, but it’s also expensive — up about 300-600 basis points since last year.

The good news is that this new, harsher reality may be short lived. Many believe the commercial market may turn around as early as this time next year. But even if the new reality remains (some argue it could go as long as 2012), owners can still get the capital they need if they get back to the basics… a good property, a sound strategy, experienced players and, above all, realistic expectations.

Andrew Benioff is founder and senior managing partner of Philadelphia-based Llenrock Group, a real estate investment and advisory firm providing investment brokerage, asset management and bridge debt capital to the commercial real estate market. 

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.