FEATURE ARTICLE, JANUARY 2009

NORTHEAST FINANCIAL FORECAST
Financial experts give their take on the state of the market and its future.
Interviews by Stephanie Mayhew

As we enter 2009, the state of the economy is foremost on everyone’s mind, and everyone is speculating on whether or not 2009 will bring some relief or more grief for those in the commercial real estate industry. This month, Northeast Real Estate Business sat down with three financial experts to discuss the current financial climate and what we may expect for the future. 

Jeffrey A. Gould is the president and chief executive officer of BRT Realty Trust. Headquartered in Great Neck, New York, BRT focuses on originating short-term acquisition and bridge real estate loans for properties throughout the continental United States.

NREB: Can you characterize the current lending environment in New York City?

Gould: There is no money out there at all for deals and there is minimal, if any, new lending. In particular, there is no construction lending at all. We are doing some new lending right now, but we are seeing deals slow because people are either stuck in deals and they can’t refinance, or they are looking to acquire properties and they can’t get financing.

NREB: Those that are able to get financing, what are they doing?  Do they have more cash up front for the deal?

Gould: Much of what we are seeing right now is current lenders getting out of deals, so there are opportunities for the borrower to buy the lenders out at discounts. Also,  lenders are putting pressure on these borrowers because they need to get out, so they are pushing them very aggressively. Or, there is no conventional financing for new deals, so people are coming to us on new acquisition opportunities.           

NREB: In a post-bailout economy, how tough is it going to be to get a loan?

Gould: I think it is going to be quite some time before we see good open lending opportunities. The real estate environment in New York City is in for some major trouble. I think the valuation of properties is in for a very significant decline and banks will be taking over lots of assets. There will also be many junior mortgage lenders and mezzanine-type lenders who are going to lose their money. In the New York City market, I don’t see anything getting much better through 2009, probably not until the later part of 2010. There will be opportunities for BRT, though. Banks with capital constraints are creating some opportunity for people.

NREB: What kind of deals have you been doing and what do you think you will be doing in 2009?

Gould: Most likely, BRT will be financing borrowers who are purchasing bad notes at a discount. I think there will be some more activity on purchase and acquisition side as well. Some sellers are going to be forced to sell and more sellers are becoming realistic about prices, which will lead to potentially more transactional business.

NREB: Do you think that most people are waiting to sell because they think their property is worth a certain amount and they don’t want to take any less?  Or do you think some will be forced to sell no matter what?

Gould: Both. Some people will be forced to sell because they just need to get out and generate cash. I think the problem in the market is that people still do not realize that their properties have gone down in value significantly and the disconnect between buyer and seller is still very dramatic. Sellers are not selling because their pricing is way too high in this world.

NREB: Are there certain property types that people are targeting for distressed buys more so than others?

Gould: Not really. A lot of loans are coming due on the residential and multifamily side, but people are looking for opportunities in all sectors. The residential rental market is down in the city and it has also become more difficult to get new retailers to take space, but I think the office market is in for the biggest crash. More product is being put on the market right now and more, such as the World Trade Center site, is scheduled to come. 

NREB: Is there anything else you would like to add about the state of the current market?

Gould: I think it is worthwhile to note that we think the biggest opportunity in the coming months is going to be buying back debt and we are assisting people to do that.

Ernie DesRochers is the managing director of NorthMarq Capital’s New York Metro office. NorthMarq is one of the largest commercial real estate mortgage banking firms worldwide.

NREB: What do you see in the coming year in terms of lending?

DesRochers: In the next year it is just going to be a continuation of the healing that is going on so far. What I mean by that is: Investment sales nationally have been down 75 percent and mortgage lending and conduits have been down 94 percent. So, there has not been a lot of market activity primarily because of the fact that commercial real estate all of a sudden tends to be a dirty word. Consequently, what I think you are going to see next year is a very disciplined approach, lower loan-to-values (LTV) and higher debt coverage ratios. A 65 percent LTV deal will be an aggressive deal next year. You will also  probably see a widening of cap rates. Lenders will take a very disciplined approach and borrowers will have to prove that they have strong credit. In terms of supply of capital? Who knows, because it changes daily.

NREB: Will we see alternative sources for loans pop up next year?

DesRochers: It is hard to speculate. Will CMBS lending come back next year?  I don’t know. Traditional bank lending will be there and insurance companies will be in business next year, but it will be a question of how much are they going to do. I think the capital is going to be a week-to-week kind of thing. A who is in and who is out kind of thing.

NREB: What is your prediction for when things will start going back up?

DesRochers: I think 2009 is going to be a tough year. I think it will be the middle of 2010, maybe the end of the first quarter 2010 before we are going to see things become a little bit easier in terms of credit. It is a matter of when does the glass become half full again. I think that is really the question we all need to ask.

NREB: What kind of deals are doing and what are you shying away from?

DesRochers: At NorthMarq we are a Fannie Mae lender and a Freddie Mac shop, too. I think multifamily will continue to get done over the next year. The other product types — it is anybody’s guess.  It is a matter of how well the market holds up. I saw an article this morning that was forecasting doom and gloom for the Manhattan office market, and if there is doom and gloom for Manhattan, what are the suburbs around New York going to do?

David T. McLain is one of the founding principals of Palisades Financial, a commercial real estate lending and advisory firm providing real estate capital to commercial real estate developers and investors through its Palisades Regional Investment Funds.

NREB: Can you characterize the current lending environment in your core market?

McLain: The lending environment in our core market is virtually non existent. I have both participated in and attended a number of credit-related conferences in that last few months and have spoken to many lenders of all categories — the former CMBS lenders, major bankers and insurance groups — and virtually all of them are on the sidelines right now. However, we are a private equity fund, so we are not on the sidelines. As an opportunity fund, we are probably in the one category right now that is still putting money out or looking to put money out.

The entire CMBS market will probably be restructured before it can come back into play — from the rating agencies on down to the type of product that they are offering, which is without a doubt is going to have to be something much simpler. If that market comes back, the deals being done will be similar to what was done a long time ago. There will be a senior piece and maybe one subordinated trounch and then your equity lump, so it is very clear cut where you fall within a loan and where the risk falls. 

No one knows where the market is headed as the economy changes daily. Right now the expectation is that whatever something is worth right now it is going to be worth less 6 months from now; thus, investors are hesitant to put money out until they feel that values have stabilized and they know exactly where they are in the cap stack.

The general consensus for putting money out into the marketplace is that it would be between 50 to 60 percent LTV, and they are now looking for 9 percent-plus pricing. Therefore, the senior chunk is going 50 to 60 percent max and if you can get a second piece, it will go maybe to 70 or 75 percent. So, in the future, deals are going to require a lot of equity to attain some depth.

NREB: You mentioned your fund and that Palisades is still looking to put money out there. What kind of deals are you looking at in this kind of market?

McLain: In this market, we are looking at two different directions. One is purchasing debt — non-performing and semi-performing distressed debt. We are out bidding on some of the debt pools that are out there right now and will continue pursuing that as more of these commercial mortgage loans are put in the marketplace for sale. Secondly, we are seeing a tremendous amount of first mortgage loan requests from people who have loans that have come due. There are also people looking to complete some projects, but they need additional financing. It is interesting because in the past our opportunity fund was focused on second-tier money. If we had a first mortgage, it was not the traditional type or not a strong project. Now, because of the slow down in lending we are getting first mortgage requests for very solid projects and solid borrowers.

NREB: What do you see happening in 2009?

McLain: I try to be optimistic about the commercial real estate market, but it is just hard to be overly optimistic about where 2009 is going to end up. For one thing, many senior lenders don’t expect to get back in the market in 2009, and if they do, it most likely will not be until the end of 2009. If that is the case, the commercial real estate market is going to go through practically a full year of virtually no debt available, which is unprecedented. The major questions are: Who is going to be out there to handle these maturing loans and where is the capital going to come from to finance projects?

In this market, there is going to be very few avenues to turn to, which is going to put further pressure on the commercial real estate market. In looking at the CMBS models, I have seen different projections, those in the industry are talking about somewhere around $88 billion of CMBS debt coming due in 2009. The deals that have not been chopped up might get extended, but the deals that have been bifurcated on many levels are going to be tough to deal with. As this debt comes due, people are going to have very few avenues for replacement financing. Thus, there could be several distressed liquidations in order to pay off this debt.

©2009 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.