GSPartners
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Volume XV | No. 46 | December 20, 2007
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KEY RATE INDICES
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Prime Rate
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7.25%
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1 Month LIBOR
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4.93%
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5 Yr US Treasury
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3.41%
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5 Yr Swaps
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4.17%
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12-MAT
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4.66%
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3 Month LIBOR
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4.91%
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10 Yr US Treasury
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4.00%
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10 Yr Swaps
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4.62%
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11th Dist COFI
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4.23%
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6 Month LIBOR
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4.78%
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30 Yr US Treasury
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4.43%
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| | Recent Trends in Bridge Debt Underwriting |
The recent credit turmoil has changed the rules of the game for bridge financing. However the impact is hard to define because, by nature, value-add transactions are widely varied. Undeterred, we will attempt to describe generic underwriting parameters for a “bridge deal” in today’s market. The focus of our discourse is traditional mid-cap ($10m-$100m), short-term, floating-rate, non-recourse, senior debt for acquisition/reposition real estate investments. Note that this admittedly broad brush specifically excludes ground-up construction, stabilized assets, full recourse banking relationships, trophy assets, and uniquely strong investment-grade cash flows.
Transaction Size: The most competitive capital sources generally like loans of $10 million or more. Loans of $20 million or more find the best execution. The large portfolio lenders offering reasonable rates are generally not set up to process small transactions.
Proceeds: Lower leverage is the first and most palpable change in bridge underwriting. While no single parameter drives this shift, following are key considerations:
· LTV: Loan-to-value ratios are still prescribed, but they are functionally irrelevant. Lenders are hesitant to estimate values in an uncertain cap-rate environment, so they use other measures to gage risk.
· LTC: Similarly, loan-to-cost ratios are stipulated but rarely the determining factor. Effective LTCs today rarely exceed 70-75%. Some lenders refuse to exceed 65%. However 80% is still possible for a compelling transaction, based primarily on the quality of the cash flow.
· DCR: Lenders value debt service from operational cash flow. Many of the lowest cost lenders now require minimum 1.0x debt coverage ratio, even on a reposition transaction. Those willing to underwrite significant interest reserve are expensive and require a strong value-add story with a large cushion on exit.
· Exit Sizing / Stress Constants: Debt yield measures are increasingly popular, and are most often the determining constraint on proceeds. Debt yield is a broad metric of stabilized debt service capacity and take-out financing. It is defined as stabilized NOI divided by the fully funded loan amount. Debt yield requirements vary, but typically range from 9-10%.
Pro Forma: Projected cash flow is critical to loan pricing and proceeds because future cash flow predicts debt service and principal repayment.
· Market Rent Assumptions: In-place and pro forma asking rental rates are aggressively tested against comparables. Lenders will typically take the most conservative position on rents.
· Growth Assumptions: Lenders primarily underwrite 3% annual rent growth. With some products (e.g. storage) and in weaker markets lenders may assume no rent growth.
· Appraisal: Lenders are leaning on appraisers to establish not only values but also pro forma underwriting. Since appraisers take a historical perspective, lenders may discount their findings to an even more conservative position. Given lenders’ increased focus on cash flow, borrowers should be focused on all the assumptions in an appraisal, not just the final value. For instance, a 70% LTV using low rents and a low cap rate may not allow a lender to achieve full proceeds due to debt service constraints using the low rents.
Term: Three years plus options to extend remains standard. Extension options may entail higher fees and performance hurdles to qualify.
Rate: Bridge loan interest rates are most often quoted as a risk-based “spread” over LIBOR. LIBOR spreads vary widely based on transaction characteristics, but 2.50% to 3.00% is typical today. Any unusual risks push spreads to 3.50% or 4.00%. Large, low-risk transactions can still find pricing in the 2.00% to 2.25% range.
Fees: 0.5% to 1.0% in total lender fees was common six months ago. 1.0% to 1.5% is now more common. This shift is driven by the changing power dynamic between borrower and lender. However lenders may also face higher yield requirements today; raising fees (rather than raising spreads) provides additional revenue without straining debt service coverage.
Recourse: While this summary explicitly excludes traditional recourse/bank-relationship lenders, more and more non-recourse lenders are looking to borrower financial capacity to mitigate risks. For challenging or low cash flow transactions, lenders may request limited repayment guarantees (e.g. top 20%) or other credit enhancements (e.g. letter of credit).
Sponsorship: Attractive sponsors must demonstrate prior experience with respect to market, product type, transaction size and business plan. Liquid assets and a low-leverage balance sheet bolster the lender’s confidence in the sponsor’s ability to solve problems.
| | | | Transaction Description: | | $80,000,000 Non-Recourse Refinance of a Partially Entitled 10,000 Acre Master Planned Community in San Bernardino, CA. |
Challenge:
1. Borrower wanted to double the property’s existing debt to provide sufficient reserves to carry the property through entitlements. However, land values have dropped significantly and the market has become illiquid, making it difficult for lenders to value an asset with entitlement risk.
2. The large loan request, distressed residential market, and the capital market meltdown eliminated many financing sources that would have competed aggressively for the loan earlier this year.
3. Spreads on partially entitled land have widened out significantly; additionally, most potential lenders were requiring full or partial recourse.
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Solution:
1. GSP determined that an appraisal was necessary prior to presenting the financing requirement to lenders; with a $375 MM appraised value, GSP was able to show lenders that at 22% LTV, their exposure was minimal.
2. GSP brought the transaction to over fifty lenders in order to identify which institutions were still lending on land.
3. GSP determined that the best execution was to negotiate a new loan with the existing non-recourse lender extending the term and doubling the available funds. With no lock in or prepayment penalty, the Borrower will be able refinance with a less expensive lender once the capital markets have returned to a state of normalcy.
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| | | Transaction Description: | | $6,375,000 Cash-Out Refinance Loan for Retail Center in the Inland Empire. GSP arranged a permanent loan refinance for a 70,000 sq.ft. retail center in San Bernardino County. Having previously owned the property free and clear, the borrower extracted $6.3 million cash. GSP negotiated to have a portion of the property designated for future development to be automatically released from the lender’s collateral upon completion of subdivision. Lender renewed rate lock at lower rate, with no additional deposit. |
Challenge: The largest tenant is a church that occupies over 50% of the center. Lenders were concerned that if the tenant defaulted, the property would not be able to debt service. |
Solution: In addition to a lease guaranty, GSP helped show the lender that the rent for the church space is substantially under market and the space would likely be released quickly at even higher rents. |
| | Rate: 6.16% (10 Yr CMT + 1.80%) | | Term: 10 yrs | | Amort: 30 yrs | | LTV: 75% | | DCR: 1.23 | | Prepayment: 5,4,3,2,1, then open | | Lender Fee: 0.25% | Non-recourse, except lease guaranty for major tenant.
No impounds or reserves.
Lender held to all original terms.
Key Players: Farzin Emrani, Anna Saucier
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| | | Looking for Non-Recourse Balance Sheet Financing? Nationwide lender offering up to 75% LTV, and very attractive pre-payment terms. Eligible properties: High quality stable assets with solid tenancy and no major rollover risk located in strong/stable primary or secondary markets. Assumable with Lender’s Consent. 30 day early rate lock offered with no MAC, but 2% deposit required. Mezz debt may be available up to 85%.
Prepayment:
5 year term: Yr1,2 - locked out, then 2,1,open
7 year term: Yr1,2,3 - locked out, then 3,2,1,open | | Transaction Size: $5-100M | | Rate: Swaps + 175-225 | | Loan Term: 5, 7 yrs | | Amort: 30 yrs | | Max LTV: 75% | | Min DCR: 1.20 | | Non-recourse | | Property Types: Office, Retail, Multifamily and Industrial. Hotels (selective, full service only). High quality CTLs may also be considered | | Geography: Nationwide |
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| | | Year End CMBS Update | The year in CMBS reminds me of the proverb “May you live in interesting times.” Spreads on 10 year full leverage loans (among originators that are quoting) range from T + 2.75% to 3.30% and up. Lenders have very little certainty of where the bonds will trade at execution as the bidding has been very fickle. Recent comments by Wall Street traders and loan officers: (1) The market does not like “concentration of risk,” ie. big chunks of pools from one product type (such as hotels) or one geographic area; (2) Interest only is taboo, even for low leverage loans. The market perceives interest only as part of the “old underwriting paradigm” that overheated the market in early 2007; (3) January 2008. A well branded low leverage pool is scheduled to go to market. All eyes will be on the execution of this pool (and other “standard issue” pools going to market at that time). Originators are hoping that bond buyers flush with new annual allocations and the relative scarcity of CMBS new issues will result in tightening spreads and a more stable market. Hopefully bond buyers will recognize the more stringent underwriting that took effect in second half 2007; (4) Overhang - how much is there? Estimates of unsold CMBS bonds being held by originators range from $15-$50 billion. (5) Bond buyers. The “fast money” buyers such as hedge funds are not in the market at this time. These funds were buying much of the middle tranches (BBB and below, except for the B piece). It will be interesting to see what returns need to be offered in these tranches to attract buyers. Stay tuned… (David R. Pascale, Jr.)
| | | Speakers Corner |
1/24/08
Steve Bram, GSP Principal/Senior Director will participate in a panel discussion at the Central City Association’s Annual Luncheon on January 24, 2008. The theme will be “The Southern California Housing Market - How will Downtown Los Angeles Fare Compared to the Region in 2008?” Over 200 people are expected to attend.
Moderator:
Michael Gottlieb - Editor, California Real Estate Journal
Panel:
James Atkins - Principal, Williams & Dame
Deborah Beveridge - Senior Vice President, East West Bank
Steve Bram - Principal/Senior Director, George Smith Partners
Mark Tarczynski - Senior Vice President, Urban Redevelopment Group, CB Richard Ellis
Date: Thursday, January 24, 2008
Time: 11:30am -1:45pm
Place: Downtown Los Angeles Marriott - 333 S Figueroa St. | | | Join Us As We Reach New Heights | At George Smith Partners, we are looking to expand our team of top-notch mortgage brokers – originators and assistants. We offer highly competitive compensation and an excellent environment in which to work, learn and be supported. GSP is committed to providing our employees with cutting edge market information, resources for identifying the best capital sources for each transaction, training opportunities and peer support whenever it is needed.
We invite you to consider a career with George Smith Partners. Please direct confidential inquiries to Todd August, Chief Operating Officer, at (310) 557-8336, Ext. 125.
| | | HAPPY HOLIDAYS! |
GSP thanks all of our clients, lenders and associates for an excellent year, despite the challenges of the last quarter and a half.
No FINfacts next week… See you in 2008.
Happy New Year!! |
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©2007 George Smith Partners, Inc. FINfacts is an ePublication of
George Smith Partners, Inc. For Promotional Purposes Only. All Rights Reserved.
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