The unavailability of credit during the past several years resulting from the virtual disappearance of the CMBS market, severe impairment to bank balance sheets, and the downturn of the commercial real estate market generally has altered standard lending practices and the lender/borrower relationship. Gone are the days when lenders undercut one another for mediocre deals (at least for now), and once again the person by Dean Pappas and Jennifer Sung
Borrowers
Asking Lenders –
who holds the purse dictates the terms.
Although the shift in leverage from
borrower to lender has varying ramifications depending on the quality of particular
deals and the creditworthiness of particular borrowers,
every commercial borrower in today’s market should
expect certain fundamental changes from the commercial
lending market of four years ago.
Underwriting Standards
Stricter underwriting standards prevail for all types of
loans manifested most notably by lower loan-to-value (LTV)
and loan-to-cost (LTC) ratios. Typical LTV ratios for both
permanent mortgage loans and construction loans now
range from 50% to 65%, well below the 80%-plus range that
was prevalent in 2006 and 2007. Some lenders are also
limiting their borrowers’ overall leverage and/or otherwise
restricting or prohibiting junior indebtedness, including
mezzanine debt. The reduction in LTV/LTC ratios and other
restrictions on leverage have left a large gap in the capital
stack to be funded by equity or, to the extent permitted by
the loan documents, equity-type financing (e.g., preferred
equity or mezzanine debt).
In addition to the reduction in LTV/LTC ratios and other
restrictions on leverage, lenders are seeking stronger
credit to support recourse obligations under their loans,
such as completion guaranties, recourse carve-out guaranties, and environmental indemnities. Specifically, lenders
are imposing higher net worth and liquidity requirements.
Often, the sponsor or developer in a joint venture relation-
ship is unable to satisfy the lender’s credit requirements,
leaving the capital partner as the sole or joint source for the
recourse obligations under the loan. Of course, the provision
of guaranties by the capital source will often result in material
changes to the terms of the joint venture arrangement,
including increases to the capital partner’s preferred return
rate, reductions to promotes, and the negotiation of
comprehensive contribution and indemnification agree-
ments among the partners. Moreover, in order to mitigate
its risk, the capital partner may negotiate for additional
management rights over the business of the venture and
the day-to-day management of the real property. For many
capital providers, these additional management rights may
significantly strain their limited human resources.
