FINfacts Newsletter XV-38

Volume XV  |  No. 38  |  October 11, 2007   Letter to the Editor   Print PDF KEY RATE INDICES Prime Rate  7.75% 1 Month LIBOR  5.11% 5 Yr US Treasury  4.41% 5 Yr Swaps  5.03% 12-MAT  4.86% 3 Month LIBOR  5.25% 10 Yr US Treasury  4.69% 10 Yr Swaps  5.29% 11th Dist COFI  4.36% 6 Month LIBOR  5.22% 30 Yr US Treasury  4.90%     Market Trends GSP Managing Director/Principal Gary E. Mozer attended two conferences last week, the International YPO Real Estate Round Table, where he was Conference Chair, and the University of Wisconsin Real Estate Trends Conference, where he was Moderator of the Finance Panel. Both conferences gathered experts together who discussed trends in the Real Estate markets in the US and internationally. Following are some of the key points and opinions discussed by conference participants and speakers:   Debt: Last cycle: Too much capital in the market, risk premiums were diminished as risk was being passed on to inexperienced bond investors, too much financial engineering, huge liquidity as investors were not real estate professionals, unsustainable absorption levels of bonds because hedge funds were buying up repo lines, repackaging them, and selling them as CLOs and CDOs. CMBS issuance tripled in last five years.   This portion of cycle: “Overcorrection” is occurring, capital has slowed to a “crawl,” risk premiums are increasing, values are moving downward for both real estate and older vintage “paper.”   Paper is now clearing on Wall Street with tighter spreads on better quality paper. Super senior AAAs are trading at Swaps + 62. There is now price talk about the TOPS transaction, that super seniors will tighten to Swaps + 43. This will lower the pricing to the end-user and potentially alleviate some of the upward pressure on cap rates.   Equity: Equity was being priced like debt without considering the relative risk. Underwriting standards deteriorated until debt was taking equity risk but not being paid for it. Equity was betting on the residual play, the benefits from financial engineering and positive leverage.   Today it is difficult to underwrite stabilized debt terms and exit cap rates. Yield goals for developers typically are now 200 bps over exit cap… but what is the exit cap? Cap rates are expected to rise 50-125 bps, depending on the market (primary or secondary, soft or strong), sponsorship and product type.   During the last cycle, according to Nacref, 13% returns were attributable as follows: 9% from cap rate compression and 4% from increased property economics. Some investors think that the next cycle will see 11% returns: 13% from increased property economics and negative 2% from cap rate expansion.   Land: Land needs to be “repriced” as demand has changed. Land is expensive to hold as it “eats” (taxes, insurance, interest reserve, etc) without giving off any returns.   International The weak dollar is luring foreign investors, but their focus is on trophy properties and primary markets, for which they are willing to pay premium prices. They are not interested in secondary product or markets. Cap rates may stay low only for the high end. We will see more stratification and differentiation among assets in new cycle. Dollar heavy economies will need to spend their dollars.  Real Estate Dynamics Vacancy and loan defaults are still very low. Limited new supply of commercial. Lots of dollars on the sidelines waiting for buying opportunities. This will shorten the duration and severity of the real estate downturn.   Development: Raw material costs softening recently with less demand, labor costs still high. Same concerns as equity: what are assumptions for returns (amount and cost of capital i.e. equity, construction loans, permanent financing)?   Housing: “Waiting for the bottom.” Some markets (Florida, Nevada, Arizona) saw up to 30% of SFR bought by speculators. Government assistance through Fannie, FHA, etc? Adjustable rate mortgages; what is volume of rate resets on the horizon? Will surplus housing be rented, affecting the rental markets?   Macro-Economics Economy is ok or lukewarm, but another major external event such as terrorism, $100 oil, pandemic, etc. could lead to recession. The resilience of the economy is limited. Transactions of the Week Transaction Description: $14,000,000+ Joint Venture Equity for a $100,000,000+ Residential Mixed-use (Condo/Commercial) Development in the Vail Valley, Colorado. GSP arranged over $14,000,000 of equity to complete the assemblage, entitlement and construction of 200,000+ sq. ft. of for-sale condominiums and 79,000 sq. ft. of commercial retail/office space in the Vail Valley in Colorado. The JV equity fund committed to the project pre-entitlement. The JV returns were based on an equity return multiple and a cash flow waterfall. Challenge:  1) Sponsorship is an experienced and talented partnership with a light balance sheet relative to the size of the project. 2) The Sponsorship development fees were in significant excess of the initial sponsorship investment and included the cost to add additional staff to improve the likelihood of project success. Solution:  1) Sponsorship basis was stepped-up based on the value added from the initial carry, positioning of the assemblage and entitlement of the land. The stepped-up basis allowed for the sponsor to participate in the cash flow waterfall at a higher level. 2) An incentive mechanism was also structured into the sponsor compensation for both control and savings realized during construction of the development. % of equity: 95%; 90% with credit to sponsor for value-add step-up % of capital stack: 14% Key Players: J.Jay Brooks, Anna Saucier Transaction Description: $6,240,000 Acquisition and Construction Financing, Fixed Rate, for a Multi-tenant, Owner-user Retail Center in Los Angeles, CA. GSP arranged financing for the acquisition and construction of the two story, 15,000 sq. ft. retail center strategically located several blocks from Raleigh and Hollywood Center Studios in Hancock Park. The borrower, an architectural/design firm, will occupy 70% of the property. Planned renovations will be largely cosmetic including a new exterior façade, new retail store fronts and major investment in landscaping to create a unique, high experience destination gathering place. Construction is expected to be completed over a 12-month period and rents will be pushed back to market. At funding, the lender held back $3,330,000 for interest reserve, construction and renovation costs. Rate: 7.32% (LIBOR Swap Rate + 1%) Term: 10 yrs Amort: 30 yrs LTV: 75% LTC: 70% Prepayment: Pre-payable at each fixed rate term maturity without a penalty Recourse Lender Fee: Par Key Players: Andrew Levant, Gilda Rivera Hot Money HIGHLIGHTS Private Lender Providing Equity, Mezzanine Debt, Preferred Equity and any Secondary Debt. Lender will advance mezz like equity or fund up to 90% of equity gap. Lender will invest in broken transactions and have senior lenders that will come in with them. Will do construction projects as well as subordinate debt to existing projects. Like value-add opportunities. Typically non-recourse. Primary markets, including Southern California, East Coast, Chicago, Texas, Las Vegas, Phoenix, Florida Transaction Size: $1-10M Rate: construction: 18-25%; existing: mid-teens Loan Term: up to 7-8 yrs Amort: Interest Only Max LTV: 98% Max LTC: 98% Min DCR: (none) Non-recourse Property Types: Residential (for sale and rental), mixed use, retail Prepayment: Half the stated term min yield Fees: Varies Speakers Corner October 24, 2007 Gary E. Mozer, GSP Managing Director/Principal, will be speaker/moderator for the CRCGreen Council at the ULI Fall Meeting in Las Vegas, NV. The session title is “Capital Markets – Debt Market in Disarray!”   October 30, 2007 Steve Bram, GSP Principal/Senior Director, will be a speaker at the Commercial Real Estate and Capital Group of the Jewish National Fund’s inaugural panel event. Mr. Bram will participate in a panel discussion titled, “Real Estate Today: Challenges & Opportunities.”  Other panelists include: -- Stuart Gabriel, Director, the Ziman Center for Real Estate -- Carol Schatz, Central City Association of Los Angeles -- Jay Newman, COO, the Athens Group; Project director for the Montage Hotel project on Beverly -- Clyde Stauff, Senior Vice President, Colliers International -- Moderated by: Loryn Dunn Arkow, Partner, Cox, Castle & Nicholson LLP   Join Us As We Reach New Heights George Smith Partners is in the midst of a record-setting period of growth. As we continue to reach new heights, we are selectively seeking several seasoned and successful financial professionals to join our team. Please direct confidential inquiries to Todd August, Chief Operating Officer, at (310) 557-8336, Ext. 125. ©2007 George Smith Partners, Inc. FINfacts is an ePublication of George Smith Partners, Inc. For Promotional Purposes Only. All Rights Reserved.