What are the best ways to get a commercial property loan?
Listen to Duke Long, a commercial real estate broker, and Mike Manning, VP of Marketing at LoopNet, ask three financial experts for advice about how investors can increase their chances of getting funding.
- Frank Tardif, Managing Partner at IRERIS, LLC
- Jeff Ballaine, Vice President/Income Property Loan Officer at Washington Federal Savings
- Dan Chambers, Partner at Troutman Sanders, LLP
Listen to the entire audio call here or select specific sections. Or read transcript highlights below.
Who is Funding CRE Now?
Shift in Willingness to Make Loans
Impact of FDIC Involvement
Regulatory Pressures from Bank’s Perspective
Sweet Spot for Getting Funded
How to Get Funded
Who is Funding CRE Now?
DUKE LONG: Please give us a quick overview of the major sources of funding that are still available for commercial investors in the sub $10 million market properties today. Which ones are actually making loans and which ones are hunkering down?
FRANK TARDIF: There are a number of players that have come back in a very real way to the commercial real estate market. Having said that I should say next who isn’t back? Perhaps who is not back in are the smaller banks, community banks, sub regionals, possibly some smaller regional banks that are capital constrained and have large exposures already in their portfolios and commercial real estate. Making new commercial real estate loans uses up too much capital versus other investments, whether it be bonds or single family residentials, so it’s just too costly for them to do. However, it’s really surprising who has come back in: the very large banks, the big players, the too big to fail banks are very much back in through their middle market organizations – and that is showing up in their figures and their quarterly reports and call reports. There are insurance companies who are back in. Insurance companies always have to put money out. They have money coming in, they’ve got to put it out. They have an allocation that always has to go to real estate. Everybody needs to be – right now it’s usually about 8% of whatever they’re investing that year has to go into commercial real estate.
Shift in Willingness to Make Loans
MIKE MANNING: My understanding is insurance companies got priced out of the market over the last couple of years. Are you seeing their involvement in making loans in this space relatively consistent over the last several years or is there a shift in their willingness to make loans?
JEFF BALLAINE: I think there has been a shift. I see them getting more active with each and every week, really. As Frank mentioned they do have this need and requirement to get money out and distribute it evenly across investment types and commercial real estate is a big part of that. For a while they were satisfying those needs and those requirements by investing in commercial mortgage backed securities with the conduits not generating those and bringing those to market anymore, they’re back to direct lending. In our markets we’re seeing a significant pick up in activity from them. And they’re being very competitive rate wise.
MIKE MANNING: Who are you competing against for loans and who should people who are looking for loans be thinking about in terms of approaching specific lenders for deals?
JEFF BALLAINE: We are competing against exactly who Frank said. The smaller to mid-sized life insurance companies that have an eye for those loans in the $1 to $10 million range. You get, you know, somewhere around $8 to $10 million and up and it starts really attracting the institutional level sources of money and it’s hard for us to compete with those programs from a cost of funds and rate perspective.
But, we’re going to compete against the smaller life companies, we’re going to compete against and we are competing against the larger commercial banks. The too big to fails are getting active in all of the markets they have a physical presence in and we’re seeing that. And then there are a few of the healthier regionals, large to medium sized regional banks that have remained healthy. Investors out there should be thinking about who I have seen in the newspapers that have been on the acquisition side during this meltdown, versus the ones that have been in the papers because of problem loans or issues with the FDIC.Impact of FDIC Involvement
MIKE MANNING: How does the involvement of the FDIC or other regulatory bodies impact the ability to dispose of real estate assets both from an investor’s perspective and a bank’s perspective?
DAN CHAMBERS: I’ll start with the bank side because that’s primarily what I deal with but the major obstacle to any FDIC involvement from the bank’s perspective is the appraised value of the property and also what the book value of the property is listed at the bank. That really drives what the bank can take from an outside purchaser for that particular asset and so really the FDIC overlay creates some problems from the bank’s perspective in terms of very narrow parameters that the banks can normally deal with once they get an appraisal.
One of the banks I work a lot with that is working through an FDIC portfolio now has to have their assets reappraised every six months (and if a charge off is appropriate at that time, it will be made) but what that does really is set the bar in some very strict parameters that can range anywhere from 10% to 15% off that appraised value beyond which the bank really has little discretion to dispose of the asset for a price much in variance of that. So it really does handcuff the banks to some degree in terms of what they can do with the FDIC.
The other major component is the delay factor. The bank generally will have to take any deal that comes in, put it before loan committee approval, also get the blessing of the FDIC. That can be a cumbersome process and it takes additional time which a lot of times obviously will test the patience of the investor on the other side. So, for an investor it can change how they can acquire the property and what form that might take for them.
MIKE MANNING: Why is it that the FDIC has it to allow a note purchase as opposed to forced through foreclosure and then an REO sale?
FRANK TARDIF: I might have some insight into that having been at the FDIC Division of Liquidations back in the old days, and now dealing with these loss share agreements that an institution that is acquiring a failed bank and has a loss share agreement with the FDIC where the FDIC is taking on 80% of the loss on certain assets for say an eight year period. The issue has always been appraised value for the FDIC and, in fact, it’s been so much of an issue back in 1994 I wrote an article for The Appraisal Journal exactly on how to go about valuing distressed real estate essentially for the FDIC that is available on my LinkedIn.com page for download if anybody wants it.
The issue is the FDIC, some parts of the organization is able to think in a capital markets context so the sale of a distressed debt note is the sort of a package in a structured transaction something they can do through third parties. October’s Private Equity Real Estate magazine had an article about FDIC structured transaction sales, but those are sales of whole portfolios. But there are these various layers and even the banks that have acquired other banks and are now managing the distressed assets under these loss share agreements are very often at a loss for exactly what the FDIC wants.
JEFF BALLAINE: And, Frank, can I follow up on that quickly. That’s a great point. There is a lot of uncertainty internally at the bank about what is and what is not acceptable. I think it’s important for an investor that is looking to acquire an asset, and maybe they’re outsourcing financing through a commercial lender or other avenues to try to acquire that asset, these loss share agreements that Frank is talking about, at least all the ones I’ve been involved in the FDIC mandates, that the acquiring bank treat those assets as if they were their own assets. In other words the acquiring bank is not allowed to fire sale these assets to work their way through the portfolio quickly. They are under the same duty to treat those assets as if they were their own originating loan and their own asset. If the investor has that knowledge going in, I think it avoids a lot of situations where the investor might come in and make what could be considered a ridiculously low offer with the hopes that the bank can simply sell it at whatever price, not understanding that the bank is under much tighter regulations in terms of their duties to the FDIC to manage and dispose of the assets.
MIKE MANNING: What advice would you offer to an investor who was looking to acquire an FDIC asset?
JEFF BALLAINE: Well, I think the #1 thing is that the investor has to be realistic about the purchase price. That means – and, as I said before, the bank appraises every six months until the asset is disposed of – they’re getting an appraisal done. I think it behooves any investor if you’re going to acquire or try to acquire an asset from a bank that was a failed institution. I think it’s important that the investor go out and get their own appraisal because, as Frank said that’s really what is going to drive everything. Most of my bank clients I don’t share my appraisals that I do with the investor and their team. That’s work product for me and my bank to deal with. I think it makes sense for the investor to go spend the money to have an appraisal done so they have an accurate idea of what it’s worth because the reality is the bank’s already done their homework and they’ve done the math on how much variance off that appraisal to go to make a deal happen. I think the investor saves a lot of time and aggravation if they go out and get their own done so that everybody at the table has a realistic idea of what that asset can be acquired for.
FRANK TARDIF: Dan’s insights are very accurate and they add value to the thought process of anyone who wants to acquire a property where the FDIC is involved. I will say this, in terms of the appraisal process: most investors are sophisticated enough and know their markets well enough. They probably know as much as the appraisers will, so whether they spend the money for their own appraisal is really up to them. As usual the bank and the FDIC couldn’t care less about Joe Shmoe’s appraisal that he’s paid $6,000 or $10,000 for. The issue right now is appraisals because there are few real market rate sales in many, many markets. Although financing is coming back to help the appraisers develop, say a blended cap rate and start to have some cap rates, there are very few sales. Valuations of the properties are extremely difficult and that is partially why the transactions have been difficult because the players, the sell-side players that are involved with the FDIC are really unsure about the value, even though they have an appraisal. They’re really unsure about it and the offers they get may not be close enough to it.
Regulatory Pressures from Bank’s Perspective
DUKE LONG: What do the regulatory pressures look like from a bank’s perspective?
JEFF BALLAINE: What we’ve already heard is extremely accurate in terms of the added layers. What we’re seeing on a day to day operational level is way more time being spent on portfolio management to determine whether or not our values are appropriate and do they need updating and indeed I am aware of many institutions that we compete against that are in our marketplace that are reevaluating their entire portfolio every six months just like Dan suggested.
Because of the way the regulatory audits have gone over the last couple of years and how the scrutiny has really drilled down, they’re looking into the way we’re also tracking things like loan covenants and the like. So, all of this sets a tone, right? And then you go out and you try to produce and this is all in the back of our mind. We have to be thinking about how is this going to look to the regulators when it’s on our books as we look at new opportunities.
The other thing that the regulatory pressures have done is really place a focus on the way lenders of all kinds out there are evaluating borrower and guarantor financial capacity. I think there were a great deal of problems out there if you talked to lenders that were the result of the deal in our portfolio being fine, but that borrower being a little bit overextended and a deal with another lender going sideways and it catching all of the other creditors off guard.
Sweet Spot for Getting Funded
MIKE MANNING: What is the sweet spot that you think is most likely to get funded?
JEFF BALLAINE: Well, you know, loan size I think is still being driven more by the size of the institution and the markets that they are participants in. Washington Federal does not have a presence in, nor do we actively pursue business in Southern California, for instance, but the projects down there tend to be much larger, and the loan size is greater, and we’re all looking at our ratios and trying to make sure that we’re not extending too much on a percentage basis to individual loans or to individual investors.
Property types: Multi-family is the property type that’s going to have the easiest path through any lender’s shop right now, and that’s because the economic fundamentals are there for multi-family right now. Vacancies are falling across the board; rents are going up in most major sub-markets. Another contributor to the strength in multi-family is the draw away from home ownership by the younger generation. They seem to like renting vs. ownership. They’ve seen what happened to the equity their parents had in their homes that they grew up in, and that scares them a little bit. But there’s also a shift in the amount of time that individuals are spending at one job now, and the flexibility to move is important as career paths veer, and so, again, it makes multi-family a far more attractive and is helping their underlying economic fundamentals pencil out a lot more rapidly than the other three major—
MIKE MANNING: To get a specific number, you mentioned you don’t want to go too far in a loan-to-value ratio. What was it maybe three years ago, and where is it now? What could people expect when they’re coming and looking for a loan?
FRANK TARDIF: If I might jump in here, I was at the Federal Home Loan Bank in 2004 and 2005 reviewing loans from major regionals down to community-size banks, and here’s the harsh reality, and if owners won’t recognize it, brokers will probably recognize it. The harsh reality was loans were being done at 100% loan-to-value. The appraisals were just like in the ‘80s with the S&L crisis. The appraisals were extremely optimistic, and somehow if a borrower was buying a property for $5 million and, you know, needed a value of $6 million for that loan to be $5 million, well, damn if that value didn’t end up being $6 million.
DAN CHAMBERS: There’s a perception that there’s kind of a mismatch between brokers, investors, and bankers about what constitutes what today would be a solid loan. What’s your perspective on that?
FRANK TARDIF: There is a mismatch, and I can appreciate all parties involved, but it’s pretty much driven by really where each of those players are coming from, how they’re being paid, how they make their money, and it’s important for all the players to appreciate everyone else’s situation. Brokers are transaction-driven. They eat what they kill. It’s part of the process. Those dynamics have a great influence on their perceptions of value and deals, and I’m talking about real estate brokers as opposed to mortgage brokers. Mortgage brokers are more capital markets oriented, and they’ll probably be more realistic.
JEFF BALLAINE: It’s really defining the solid loan and recognizing that we will do good loans on good properties, and it’s not our business to make loans that we think expose our investors or ourselves to too high a risk.
MIKE MANNING: I would say, in a way, that it’s a return to normalcy happening right now. It’s not so much that bankers are making, from your perspective, unrealistic requirements, but that the market perhaps got used to unrealistically loose requirements. One-point-two-five is the debt service coverage ratio that you’re looking for now, and the loan-to-value just is a number without a lot of explanation around it would be around what?
JEFF BALLAINE: Really depends on the product type, but anywhere from 70% to 80%. Multi-family, some lenders are going up to 80% right now. You know, the difficulty, again, is lenders are looking at a combination of loan-to-value and debt coverage in markets where CAP rates did not go up dramatically during this down turn. It’s still extremely difficult to get to an 80% or 75% pay-per-value if you’re underwriting to a 1.25 debt coverage. You’re really going to be in—I’d say the sweet spot is going to be somewhere between 68% and 72%.
FRANK TARDIF: There is some private equity, secondary financing, something out there that’s useful to people. But Dan, I wanted to ask you, because you’re in the thick, I’m sure, of unwinding so many of these loans that did have multiple layers of debt and how complex that is to get the property free and clear so it gets to a point where it can be transacted.
DAN CHAMBERS: That’s been one of the difficulties obviously, and, to further compound it, a lot of these assets that had the multiple layers either had no inner credit or agreement among the lenders, or, if they did, it was very poorly drafted, because at the time it was drafted it really didn’t matter what it said, and it can create all sorts of difficulties both inside of bankruptcy and out, trying to sort out the rights of the parties.
So obviously they’re out there, and I think Jeff’s point is right on target. The banks that we work with on the lender side, it really is a ratcheting back to more conventional lending practices, and we’ve seen LTVs even as conservative as 60. Again, depends on the product type, but it’s a return to more conventional lending guidelines and, frankly, not taking guarantees from people that are loaded down with real estate as, you know, what’s pumping up their balance sheet or their financial statement and getting back to is this investor, is this borrower backed by strong equity, and is it a good product?
How to Get Funded
MIKE MANNING: What kind of advice would you give to an investor hoping to purchase a sub-$10 million property and preparing to make a presentation for a loan?
JEFF BALLAINE: My advice would be, right off the bat, be realistic about your assumptions. Don’t short on your estimated expenses. Take a hard look at what the broker package says and try and verify as much as you can. Don’t get too aggressive in your suggestions as to what opportunities there are for income growth. Until we see some real uptick in job growth, I’m not sure we can really expect income at the various commercial product types to really be increasing at a level that’s going to make much of a difference in our evaluation. And be an open book about your personal financial condition.
Back to what Dan said, I think real equity is absolutely critical today. If your portfolio is all real estate based, we’re going to take a hard look at the real estate values that you’re reporting to really determine what’s behind the deal there. Talk to us early in the process. I think that that’s been really helpful in the deals that we are seeing transacting right now. I’ve got relationships and I know a lot of folks in town that I work with or compete against have developed strong relationships with the brokerage community. We’re looking at the deals early in the process, even, in some cases, providing quotes that the brokers can then go out and show potential investors. But as an investor, feel free to contact the banks early in the process, because, as mentioned at the very beginning, we are hungry for new loans, and if we can get in early and talk and help manage everybody’s expectations a little bit, I think it will help the process along.
MIKE MANNING: Dan, what is your perspective, quick advice for people looking for loans?
DAN CHAMBERS: The underwriting standards obviously have gotten much, much tighter. I think investors need to be realistic about values and, as Jeff said, I think you really need to take a very conservative approach to your projections. And finally, and I can’t emphasize it enough, you’ve got to be backed by strong equity, because, again, underwriting standards have tightened. That’s going to be scrutinized a lot more, so I think you just have to come to the table with realistic expectations and credible numbers. That’s really the key.
FRANK TARDIF: First is the strategy. Always buy the debt before trying to buy the property. If you’re able to buy the debt, it’s yours. You have a lot more options, a lot more flexibility, and you’ll end up with the property anyway. The second thing is I would suggest to everyone to listen to Ben Bernanke’s speech he gave at the National Press Club yesterday. It’s on the National Press Club website, and he’s saying, and I completely agree, that employment in this country is not going to get back to normal levels for five years, and many respected economists believe it’s going to be much longer. Essentially you can’t take $13.7 trillion of household wealth and wipe it off the balance sheets of consumers and expect to have the same economy.
The housing boom was supporting many, many players throughout the country, so whether that real estate is really going to perform, again, in the way people might want it to is something that everyone has to look at really hard.