By Dan Rafter
It’s easier today to get financing for the new hotels, multi-family buildings and strip centers that you want to build. And if you want to purchase that office tower in downtown, you’ll find plenty of banks and lenders willing to provide you with the acquisition funds you’ll need.
But don’t expect lenders and banks to just hand you this money. You’ll still have to work for those dollars.
That’s the message from two lending pros working the Midwest, Pat Dempsey, senior vice president with Walker & Dunlop, and DJ Effler, senior vice president in the Columbus office of Bellwether Enterprise.
Both lending pros said that developers can nab financing dollars today. But they’ll first have to prove that demand is high for whatever hotel, apartment complex or mini-mall that they’re building. And they’ll also have to show that they have the positive cash flow necessary to repay their loan on time.
Those developers and investors that can do this? They’ll find plenty of money available in today’s lending market.
“The capital markets are incredibly healthy right now,” Effler said. “There is a lot of capital out there.”
Part of the reason? In addition to more traditional lending sources, the CMBS market is strong today. Effler says that this is good news for anyone seeking development or acquisition funding.
As Effler says, when the CMBS market is running well, that forces life insurance companies, banks and Fannie Mae and Freddie Mac to be more competitive with their own lending terms.
“That’s great news for borrowers,” Effler said. “And that is what we are seeing today. We are seeing deals being done at incredibly competitive interest rates. We are seeing lenders take a little more risk. It’s not crazy risk, but it is more risk. It’s really good to be a borrower right now.”
The CMBS numbers bear this out. As Effler says, in 2007, CMBS issuance peaked at an incredible $229 billion. Two years later, though, after the country’s economy crashed, CMBS issuance dropped to $2.7 billion.
“That was a 99 percent decline in CMBS issuance,” Effler said. “The market was dead.”
But in 2013, the CMBS market began its rebound. That year saw $86.1 billion in CMBS issuance. Effler hopes that the CMBS market in 2014 will hit an issuance of $100 billion.
If this happens, expect financing to become even more available to borrowers in 2015 and beyond.
But, of course, only to the right borrowers.
Dempsey, from Walker & Dunlop, says that his company looks carefully at borrowers themselves before loaning them commercial real estate dollars.
First, Walker & Dunlop studies the track records of borrowers when it comes to developing a certain product type.
“Have they developed this product before? Do they have a good experience not only in developing the product but in operating and managing it?” Dempsey asks.
For new development, borrowers must also have a decent net worth and liquidity, Dempsey says.
“There are construction risks on new assets,” Dempsey said. “Sponsors have to demonstrate that they can cover cost overruns on new development.”
In a perfect world, Dempsey says, borrowers would have a net worth that is at least equal to the amount of money they are requesting. From a liquidity standpoint on a new development request, Walker & Dunlop officials want borrowers to have a net worth equal to 10 percent of a project’s costs.
This helps guarantee that borrowers can cover items such as cost overruns or additional tenant costs, Dempsey said.
Credit history plays an important role, too, Dempsey said. Those borrowers who have a long history of treating banks well and paying their loans back on time are more likely to receive financing.
“How did they fare during the last recession?” Dempsey asked. “Did they give a lot of properties back? How did they handle the tough times? Did they file bankruptcy?”
Many borrowers suffered credit issues in the last downtown, Dempsey says. If these borrowers treated their lenders well and, say, didn’t file lawsuits against them, they are more likely to get financing today, Dempsey said. If they filed for bankruptcy protection or sued their lenders? The financing dollars might not be as available.
Walker & Dunlop officials take a close look, too, at the strength of the development that borrowers want to build or the properties that they want to acquire.
“The most important thing there is the market strength and depth,” Dempsey said. “Is there already product like it in the marketplace? Is that product performing well? Will the market support this property?”
For instance, multi-family properties across the Midwest are performing particularly well today, Dempsey said. For the last several years, multi-family has boasted high occupancies, low concessions and little bad debt. Because of this, developers can more easily find financing dollars for new multi-family projects.
Those seeking development dollars are more likely to earn them if they are proposing a higher-quality project, Dempsey said.
Today, the financing dollars are flowing most freely for, of course, multi-family projects.
But developers and investors are finding financing for a wide range of property types in addition to apartments. For new construction, the second most active market for financing dollars are high-quality retail and industrial projects, Dempsey said.
Hotels and seniors housing projects are also receiving a significant share of financing, he said.
The one sector where financing is still sluggish? Office, Dempsey said, continues to be a laggard.
Different markets, too, are seeing more financing. Dempsey points to the Midwest markets of Chicago and Minneapolis as being especially strong today, with plenty of new-construction projects receiving financing.
To take advantage of this financing, though, borrowers need to have cash on hand, Dempsey said. In 2006 and 2007, borrowers were able to finance their projects with little cash invested. That has now changed, with Dempsey saying that banks need borrowers to provide at least 15 percent to 20 percent real cash when seeking financing for most projects.
A local game
Most borrowers today will be working with local, community lenders, Effler said.
“In the Midwest, especially, you are usually not going to have a national bank, unless you are a major borrower, providing you with your financing,” he said. “If you are a developer with just a handful of projects, if you aren’t a top-10 developer in your specific market, you will be playing with the local community bank lending sources to get projects out of the ground.”
Lenders today will look carefully at borrowers’ cash flow, Effler said. That, he adds, is a significant difference between now and 2007.
Effler explains it like this: During the recent economic downturn, banks recognized that even if the asset they are financing is strong, that doesn’t mean that their borrower can’t be hurt. If the rest of the developer’s portfolio is going south, for instance, and that borrower is struggling with cash-flow issues, it doesn’t matter how well the one asset that a bank financed is performing. The odds are good that the developer will eventually default because of the other financial disasters it is facing.
“You can still be pulled into the abyss,” Effler said. “Even if the property you financed has all the good fundamentals.”
This is a smart move on the part of banks and lenders, Effler says. But for borrowers? It can make getting financing a bit more challenging.
“Is this a positive trend?” Effler asked. “I guess that depends on whom you ask.”
For Effler, though, the banks’ insistence on looking more carefully at issues such as cash flow is a good sign for the commercial real estate market.
He says that the capital markets for permanent financing are as strong and healthy as he’s ever seen them. That’s saying something: Effler has been working in commercial real estate financing since 2002.
Effler says the market is healthier even than during the heydays of 2006 and 2007.
“There is some needed discipline in the market today,” Effler said. “That is necessary for a healthy commercial real estate market in the long-term. By focusing on cash flow versus pie-in-the-sky numbers, we are seeing a market that is sounder today. It’s not like it was during the craziest of times.”