Trends in real estate financing.

(This is the third in a series of six commercial real estate articles being penned by CREW-NY (Commercial Real Estate Women-New York). Each column will focus on emerging trends in a given area of commercial real estate.)

Reports from all quarters tell us the Manhattan real estate market is definitely on the rebound. Rental rates have increased and sale prices are starting to climb, but what about financing? I went to our CREW members who are experts in this field. Below are their responses to my questions.

What types of properties are being financed today?

Victoria Kahn, senior director of Jones Lang Wooton Realty Advisors, investment advisors to state and private pension funds, says "Today's money is chasing high (institutional) quality product with stabilized revenue streams in markets with strong demographics and minimal downside. In terms of retail, while this has not been a strong performing year in general, regional mall transactions continue, although not at last year's pace. CBD office product has rebounded in many markets, such as Boston, Washington DC and Seattle, as vacancy rates shrink, supply holds constant and rental rates rise accordingly. Well-built, very well-located residential property is also being favorably received for both new financing and re-financing."

"What is still being viewed with disfavor is pure development," adds Kahn. "Lenders, remaining very risk-averse, will finance current income securitized by credit tenants. Unless a development property is pre-leased to credit tenants, capital will be hard to find, costly, or both."

Daun Paris, president, Eastern Consolidated Properties, Inc., a real estate investment brokerage firm, agrees with Kahn about residential and retail properties. Says Paris, "Multi-family residential and retail properties are readily being financed. Even hotels and development land, once red-lined from a lending point of view, are now back in favor. Office buildings are still facing unusually difficult lending terms, with banks requiring 40 to 90 percent equity before they will lend. This even applies to well-located, prime Midtown office buildings."

Like Kahn, Roberta Hyman, vice president, Galesi Realty Corp., an office and retail sales and leasing brokerage firm, also reports conservative lending practices, the key being dependable, long-term, income streams. "Insurance companies and pension funds are lending on properties with credit tenants, long-term leases and triple-net leases," says Hyman. "Types of properties being financed are shopping centers with credit tenants, office buildings with credit tenants, build-to-suits for credit tenants, etc."

When it comes to lending terms, the news from the front is positive. "Interest rates are low and there is an abundance of lenders for most New York properties," says Paris. Kahn concurs, adding "Overall, the terms for commercial mortgage money are very 'workable,' given that interest rates are at record lows. At present, long-term (over 7-years) fixed financing is available from insurance companies, pension finds and via securitizations, at approximately 130-150 basis points over corresponding treasury yields. The banks have also gotten back into this market in a big way, and are very competitive as to rate. However, while lenders have ample funds to place and are anxious to do so, financing at greater than 60 percent loan-to-value, even for well-leased Class A product, is rare."

Hyman adds "There is abundant mortgage money currently available. The terms are workable as long as the project has realistic numbers and the tenants are financially stable. The terms for a property without credit tenants could require a greater input of cash, thus causing the deal to have a cash-on-cash return that is too low."

Who are the lenders?

"Traditional lenders - banks, insurance companies, pension funds - all are active players looking for very much the same product," says Kahn. "The lending perspective is differentiated more by term than product, with the banks placing five- and seven-year money, while the insurers/funds look for longer terms. Banks and insurance companies are reluctant, in my experience, to allocate more than $60 million per asset on a non-recourse basis (regardless of the debt/equity ratio)."

Susan M. Deutsch, senior vice president, Llama Company, a real estate investment banking firm, sees a diverse group of lenders. "A great deal of capital has come into the real estate markets in the past two years," says Deutsch. "Until recently it came primarily from Wall Street through conduits. Conduit money is market driven by the buyers of the ultimate securities and the rating agencies that rate these securities. The loan underwriting is standardized and there is not much room for creativity. Insurance companies, banks and, to a lesser extent, pension funds, have re-entered the market. They are competing with conduits for top quality and stable property types such as Class A multi-family housing properties and retail. Joining conduits for the remaining property types, including office, industrial/warehouse, hotels, trailer parks and storage, are the finance companies."

"In New York City, lenders that are current mortgagees dominate the market," continues Deutsch. "Values are not there yet to refinance and bring in new capital. Tenant improvements are financed by those entities with a stake in the property, i.e. landlords and existing lenders. Sales are being made by lenders that take back the property and sell it."

Is Manhattan being "red-lined"?

On the subject of "redlining" there is a lively difference of opinion among CREW members. Victoria Kahn does not think Manhattan is discriminated against by lenders. "There has been a fair amount of transaction activity within the past year, so lenders are lending so that buyers can buy," says Kahn. "I am currently completing a very large refinancing of a mixed-use facility in the Metropolitan area. Not a single lender I approached expressed any "concern about allocating investment dollars in the Manhattan market. Of course, the collateral at issue here is a Class A property which is 95 percent leased under long-term leases to credit tenants (primarily financial services). But the tenants' fortunes are inextricably linked to those of Manhattan itself."

Daun Paris, on the other hand, feels that "Manhattan office buildings are being red-lined by almost everyone. However, there is an indication that some banks and insurance companies are beginning to move into this category as the lending atmosphere becomes more competitive."

Is lack of available financing or poor terms limiting commercial sales in the market?

On the subject of the effects of financing on commercial sales, Kahn and Paris are in agreement. Says Kahn: "Prices may, in many cases, still reflect discounts from replacement value, but that has little to do with the amount of financing available, and more to do with the quality of the product offered for sale."

Adds Paris: "Commercial sales haven't been this strong in years, including sales of office buildings, despite heavy equity requirements. Particularly in the Grand Central area, office building sales have been more active than anytime within the last 10-15 years. This activity reflects an optimism on the part of the investment community that we are on the bottom of a cycle."

"In the past few months alone," continues Paris, "office properties such as 18 East 41st Street (100,000 square feet), 485 Fifth Avenue (200,000 square feet) and 56 West 48th Street (75,000 square feet) have been sold or put in contract with half or more of the purchase price funded with equity. At least ten other office buildings within five blocks of Grand Central are due to close within the next six months. Sales activity in well-located apartment properties also remains incredibly strong, with properties selling at a 67 percent return versus the 10 percent return they were trading at one to two years ago."