Contemporary real estate: dreams vs. realities.

"Perchance to dream..." Shakespeare makes for delightful drama, but lousy real estate financing. We have noticed an increasing number of landlords and investors approaching us and other financing professionals for assistance in raising both debt and equity for all kinds of commercial transactions.

Many requests are reasonable, and have a good chance of getting committed. The amount of investable funds being made available through commercial banks, thrifts, insurance and credit companies, coupled with the validation of conduits as viable vehicles for single-asset financing, has increased many-fold.

On the other hand, we've had to deal with an increasing number of nudniks whose requests were so completely ill-conceived that one has to marvel at their chutzpah... or naivete. Here are four of their most common misconceptions:

Misconception #1 Offshore Money is Dumb Money

There ain't no dumb money! Most foreign investors are not attempting to recycle income concealed from local tax collectors. Rather, they are sophisticated institutions and individuals who are looking to invest funds that might have been used locally, but are being earmarked for American properties due to depressed conditions in real estate markets back home. It's portfolio diversification in the classical sense.

Offshore entities looking to take equity positions in American properties use an analytical process far more complex than that used by an American investor. Not only are the usual computations made for net operating income, projected appreciation and cash-on-cash return, but in addition, the indicated return must be adjusted for currency risk, given that dollars will have to be exchanged for the local currency in order to repatriate the invested funds.

As the greenback continues to lose value against the currencies of America's major trading partners, the conversion computation has become so sensitive that above-average nominal returns must be achieved in order to yield acceptable results on a post-swap basis. Moreover, profit participation will be expected as a percentage of their investment to the total funds at risk. Local developers and owners are in for a nasty surprise if they think that foreign joint-venturers will supply the majority of the funds for a project without demanding, and getting, majority control. In short any thought that foreigners might be willing to accept nominal returns for a piece of America isn't just a misconception... it's delusional!

Misconception #2: Offshore Money is Passive Money

Right... and newt gingrichus is a newly discovered species of domestic salamander! Most foreign investors own commercial property back home, and have gone through the same trials and tribulations as local landlords. They expect to share invaluable operating experience with local partners with whom they participate in some joint venture. However, they also expect to be advised about the status of their investment on a regular basis, and to be consulted whenever an important decision needs to be made. Mushrooms may develop optimally when left in the dark, but any attempts to do the same to the average off-shore property owner might well result, to paraphrase the Bard, in being "hoisted on one's own petard."

Misconception #3: 75 % Non-Recourse Mortgages are Available

This is only partially true. As the conduits, including Freddie Mac and Fannie Mae, have re-entered the lending arena, the thrifts and insurance companies have been forced to back away from personal guarantees on fully rented, high-quality income properties owned by people with a track record and having a reasonable loan-to-value.

What we have seen over the past six months is an increasing number of offers for properties to be purchased on an all cash basis with returns, as we compute them, that are less than those generated by holding Treasuries. If the money isn't hot, then why is it burning a hole in someone's pockets? In our view, these deals are going to contract because some investors are computing their anticipated return-on-investment based on the seller's numbers, rather than doing their own due diligence and deflating actual, or better yet, projected net operating income, by providing adequate reserves for operating expenses, capital improvements, and tenant work letters.

Implicit in our analysis is the knowledge that valuation of the building on an actual income basis will generate a number significantly more modest than the purchase price. In short, mortgaging these properties for 75 percent of an inflated acquisition cost without investing significant additional funds in betterments is not going to happen, because the institutions still remember what got them into trouble on the last up-cycle.

Misconception #4: Subordinate Financing Shouldn't Concern First Mortgage Holder

Here we go again... Marvin Moneybags has returned! The next generation of real estate oligarchs has arisen to conquer the world, and they won't let a mere lack of cash get in their way. After they heard that some deals were done in the early Eighties with no money down, it is frustrating for them to learn that different lending policies are now in place which require the mortgagor to have real cash at risk.

Often, the more creative of this class of entrepreneurs offer to contribute equity in the form of a loan that you are asked to arrange against the guarantee of some foreign bank, and they are baffled to learn that most domestic banks have no interest in this kind of transaction. They believe it to be inappropriate that a senior lender should address itself to issues other than the amount of so-called equity in the deal. They become offended if no one suggests that an institution has a legitimate need to know about the buyer's financial condition and track record. They want you to believe that concerns about adequacy of cash-flow to service all debt, or worries about the ability of the bankruptcy of a junior mortgagee to prevent a senior mortgage holder from foreclosing on collateral, are totally irrelevant. After all, it would seem that those arcane policies were instituted for the sole purpose of preventing these future Croesuses from acquiring their first building. We were not surprised when members of this class of buyer, on several occasions, characterized our inability to arrange financing under these conditions as being demonstrative of our lack of creativity. Nonetheless, we typically ignore these comments and consider these types of meetings to have been time well-spent... if they conclude without a request by Marvin Moneybags for carfare to go home.

Real Estate is a capital-intensive industry. Opportunities are created every day for the investor with sufficient cash, and whose dreams are tempered by reality. For those buyers who lack the cash, equity partners exist... but as true partners, and not as nitwits whose assumed stupidity is exceeded only by their assumed liquidity. Success in the Niggardly Nineties will be characterized by the ability to accept and achieve consistent, modest goals. Not only is it unproductive to reflect on what financing might have been available were the contemporary lending climate still reflective of the previous decade, it is also nostalgic for the wrong reason.

We must remember that few players of the Evil Eighties escaped with their net worths intact. It was a time of greed and insensitivity whose repercussions are still felt today. Fortunes were made and subsequently lost, loyal employees fired, businesses closed, and families destroyed in the pursuit of instant wealth. As Shakespeare said in Julius Caesar: "The evil that men do lives after them; the good is oft' interred with their bones. So let it be with Caesar."

So let it be with the Evil Eighties.