He asserts that credit standards remained acceptably high through
2005, but then were lowered due to increased competition caused
by the Federal Reserve’s quickly declining interest rates. Consequently, pension funds and other investors began overallocating
their resources to real estate.
Yet current conditions aren’t so bad that debt and equity
providers have serious long-term worries. “On the commercial
side, we’ve not seen many defaults,” Levitan adds. “It also takes
time for the effects of economic conditions to ripple through.”
Indeed, even if the economy’s cooling off, there are still opportunities. McManus says he likes construction financing—“which
is like lending equity”—for multifamily, assisted living, retail and
student housing.
“Student housing is a pocket of salvation, because the demand
will always exist and rents will keep rising,” he notes. “The other
strong sector has been bridge loans, which are being made by
credit companies. Those lenders are having a great time now,
cherry-picking the high-performing opportunities at a much better
risk-reward ratio than eight to 12 months ago. Because construction is down a little, the cost of labor has also dropped slightly, so
ground-up construction becomes more feasible.”
On the equity side, Robert S. Brunswick, president and CEO of
Buchanan Street Partners in Newport Beach, CA, agrees that
there are still a few sound projects available to put money into,
but a conservative strategy is called for. “We feel that illiquidity is
here to stay for a while,” he says, “but there will be more concern
than is justified by reality. There’s always an overreaction in these
situations. We haven’t made any investments in the past four
months because owners still have unrealistic expectations as to
price and most of them don’t have to sell or refinance.
“In recent years, we’ve had a hard time investing,” Brunswick
continues. “Because of so much capital chasing too few deals,
the market was not providing appropriate yields for the risk we
were taking. We prefer current conditions because fewer players
are investing; there’s more opportunity—and a return to rational
expectations of yield for the risk we’re taking. Risk was mispriced
in the last cycle.”
As for opportunities, Brunswick says his company will provide
preferred equity and mezzanine debt, along with joint venture
equity. “It used to be hard for us to provide preferred and mezzanine, since lenders were offering 85% LTVs,” he recalls.
“Now, however, they’re making 60% loans, while we’re playing in
the 60% to 80% LTV area. And sometimes if we like the pricing,
we’ll provide the full equity. We’ve kept our powder dry and we’ll
put out a lot of money this year—but we’re not going to jump in
too early.”
Providers of permanent senior debt are likewise taking a cautious
approach, says McManus. He notes that Wall Street lenders are still
on the sidelines, and while life companies, credit companies and
banks are trying to fill the breach, they each have their own issues.
“Life companies have small allocations to real estate and very
strict lending criteria,” he says. “Borrowers stampeded to their
doors early this year and filled up their allocations quickly, so they
too are largely out of the game. Major credit companies can’t float
commercial paper anymore. Many of the small regional and
national banks have internal issues because they’ve been lending
into condo projects, to builders and developers, and those loans
are having problems now. For those banks, the appetite for origination is no longer that great. But some are offering alternatives
to bridge the gap: five- and seven-year floating-rate deals, maybe
with a couple of years of interest-only.”
Meanwhile, says McManus, Fannie Mae and Freddie Mac are
seeing so much multifamily business that lending into it, for them,
“is like trying to take a sip of water from a firehose.” They’re
underwriting conservatively and raising their rates considerably.
“Today, when I have a multifamily property, I’m more likely to
take it to a regional bank or to a company like GE, because they
“Student housing is a pocket of salvation,
because the demand will always exist and
rents will keep rising.”
Matthew McManus
Bluestone Real Estate Capital
now offer more proceeds, better structures and better pricing
than the agencies,” he says. “Moreover, when you deal with the
agencies, you have to work with overworked correspondents,
and the underwriters are too busy to debate anything with you.”
Levitan says that because of this situation, PNL, which historically has taken higher-leverage, higher-yield positions such as mezzanine or preferred equity, can now often provide senior debt.
“If a bank is willing to give 50% leverage, we can give more,”
he claims. “Much of our business comes from our ability to
recapitalize deals that have lenders or equity partners who are
timid and want out. We take high-yield positions without taking
all the risk, recapitalizing while taking advantage of discounts
from people who want to monetize their positions. Federal agencies are putting pressure on lenders to get deals off their
books, and that’s where we come in.”
Still, says Levitan, he has to exercise caution in several locations in the Sunbelt, where PNL mainly operates. The land markets
in particular are completely shut down, he notes. “There are huge
supply issues in Southern California, Las Vegas and Florida, where
new construction is still coming on line. Those are the areas we
