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TIC sponsors navigate a changing lending market.

Like many participants in the commercial real estate investment community faced with an erratic lending environment, tenant-in-common ("TIC") sponsors confront each day different from the last. Volatility in the current capital markets began in the spring of 2007 at the onset of the residential subprime loan crisis, which subsequently spilled over into commercial backed securities ("CMBS") by late summer 2007.

In this new reality, TIC sponsors brave constant fluctuations in the critical determinants of their interest rates; generally expanding credit spreads and associated swap rates.

"It used to be that a lender would quote us 100 basis points over the ten-year treasury, and 50 basis points over the swap spread, and we could reasonably rely on that," says David Eliason, Principal of Eliason 1031 Properties, a TIC sponsor that specializes in multi-family TIC offerings.

"Now that spread is significantly higher and changes on a day-to-day basis."

According to Joseph Siragusa, Chief Investment Ofricer of Cottonwood Capital, another TIC sponsor that specializes in multi-family offerings, the CMBS loan market is unstable due to a lack of transparency in the bond market.

Conduit lenders determine loan spreads based on the yield that is required for the CMBS bonds, but as Siragusa points out, "If they're not sure of what they can gel for the bonds, they can't price the loan. Some conduit lenders have responded by pulling out of the market, not because they don't want to make loans, but because they have no idea where to price them and they don't want to lose money."

Part of the current obscurity in the bond markets, according to Siragusa, is due to the lack of bond buyers right now who would otherwise help establish pricing benchmarks.

In the current underwriting environment, lenders appear to rely far more on the historical operating performance of the property than pro forma analyses, even if the sponsor has documented turnaround expertise in adding value to properties. This stricter reliance on trailing figures can affect the sponsor's ability to deliver offerings whose projected returns meet the TIC investor's appetite.

"Whereas most people understand that a more than doubling of credit spreads account for much of the increase in our cost of debt capital, more conservative underwriting standards (primarily a switch to underwriting historical cash flows and not pro-forma cash flows) employed by the providers of this debt capital have exacerbated the situation," says David Rupert, Chief Investment Officer of Griffin Capital, a TIC sponsor.

The situation would be even more serious had not a 'flight to quality' by global investors driven down U.S. Treasury yields to approximately 3.70% in mid-January 2008, 130 basis points lower than they were just six months ago," Rupert says.

"To continue to provide the investor with the same 6.8% cash-on-cash yield, the cap rate we pay to the seller would have to increase from 7.0% to 7.86%."

As an upshot, TIC sponsors committed to the long haul, and quality offerings with competitive returns for individual TIC investors have adjusted their financing--and ultimately acquisition--strategies accordingly.

These adjustments include calculating spread scenarios differently, often seeing a "rate lock" as a misnomer based on the Material Adverse Change ("MAC") clauses in the loan terms.

They are also adjusting to disappearing or severely restricted periods of interest only, and generally stricter underwriting criteria with lower LTV's and higher debt coverage ratios. Sponsors are now cultivating alternative lending sources and more carefully timing due diligence activities parallel with the loan procurement process.

David Eliason comments, "The instability of the CMBS market has made us seriously seek out other lending sources," says Eliason, "like insurance lenders, and possibilities with Fannie Mao and Freddie Mac."

Other sponsors have looked inward and re-visited relationships with regional banks.

Another way to navigate the lending process with some order is to lock in the entire loan coupon by effectively buying out the MAC clause language in the loan agreement.

In the past two quarters, lenders have relied upon MAC clauses to change the credit spread, and thus the coupon, after a borrower had rate locked.

This clause provides lenders with the ability to ensure the profitability of a loan. During the transition in the markets, some TIC sponsors have explored ways to buy out the MAC clause. However, sponsors acknowledge that having insurance on a rate lock is not free, and may not make sense if it severely impacts the cash flows over the course of the loan.

TIC sponsors typically plan and execute their extensive due diligence on a property while securing the financing.

Some sponsors will not commence with the borrowing process until critical components of their own due diligence are complete.

Obviously, sponsors and TIC investors do not welcome with open arms any last minute interest rate retrades. However, the TIC investor cash flow--as stated in a TIC's offering documents--is rarely altered.

Normally an adverse change in loan coupon, or the mechanism for preventing such a change, is borne by the sponsor who typically takes on less profit in order to preserve the projected equity returns of a deal and consequently credibility with both potential investors and the broker-dealer community.

More TIC sponsors are typically delaying the marketing of the equity offering documents until the loan is completely dosed and the sponsor has closed escrow on the property.

"We had always closed on the property before putting out the offering as a standard operating practice," notes Eliason, "and we used to get a lot of questions from other sponsors as to why."



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Comment:TIC sponsors navigate a changing lending market.
Author:Mc-Granaghan, Emily A.
Publication:Real Estate Weekly
Date:Jan 30, 2008
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