If you’re buying an existing property with in-place cash flow, and the property is stabilized, there is an extensive amount of financing options available to you, according to Jeff Bucaro, senior vice president at Aries Capital LLC.
“Those financing options have very aggressive pricing, and are highly competitive,” Bucaro said. “If you take it the next step up—I’ll call it value-add play—with opportunities to improve the cash flow, but there’s still in-place cash flow, you’re only going to make it better. There’s still a very wide range of options, and lenders, available for those types of play.”
If you’re getting into what Bucaro calls a major upgrade renovation, acquiring financing is certainly a lot more difficult.
“Maybe it’s a vacant building being converted to something with a lot of moving parts,” he said. “I’m not saying it’s impossible to acquire financing, but it’s certainly a lot more difficult than anything that has some type of cash flow in it.”
The final end of the spectrum, according to Bucaro, is ground up construction. “That’s something that is still a pretty fragmented market. If you have a very strong experienced borrower, with deep pockets, financing is available to them. For the merchant builder who just wants to build stuff and move on, it’s a lot more difficult. In some cases, depending on the product type and market, it’s very difficult.”
So what do developers have to be able to show lenders to improve their odds of getting financed? Bucaro says first and foremost, it’s the developers themselves. Who are they? What does their resume look like? What level of experience do they have? How did they perform in the downturn?
“That’s very important,” he noted. “Even if they gave back properties, or had foreclosures, it’s almost about how they performed in the downturn. Did they throw the entities into bankruptcy and fight the ledgers for three years? Or did they cooperate and provide a deed in lieu of foreclosure, and help facilitate the process?”
Overall, Bucaro said, it’s all about the character, quality, experience, and then the financial wherewithal of the developer.
“Banks don’t want to lend to people who can’t pay them back, or have a track record of not paying them back. Or if they are so financially tight that if there’s one glitch along the way, they do not have the additional capital to fund the project and keep it going.”
Practices have changed since the economic downturn, as Bucaro said; banks especially are focused on the borrower. “In pre-downturn everything was about the project,” he said. “What is it, and what are the projections? Now it’s all focused on the borrower first. Once you’re beyond the borrower, then you obviously need to have a financially feasible project. But if you don’t get past the borrower, it doesn’t matter what they’re trying to build.”
Lessons learned from the downturn? “Obviously projections really mean nothing,” Bucaro said. “Experience is everything, and character of the borrower and their financial wherewithal, is going to outweigh the sexiness of the project.”
“There were a lot of lenders going into deals just because they were the biggest and the best, and the most expensive,” he continued. “I think there were a lot of lenders really going after those projects because they were high profile, carried big names and sexy brands, amongst other things.”
If you weren’t successful during the downturn, don’t feel bad, Bucaro has good news for you. “Memories are short, people do forget,” he said. “Downturns happen. I’m not saying it’s going to happen on the same level as it did, but a cycle happens. Whether it’s every 7 to 15 years, it happens, and it’ll happen again.”
So what property types are getting the most deals today? Right now, Bucaro said it’s multi-family.
“When you look at the demographics and the growth, especially when you get into these urban environments, we’re seeing population growth and job growth to an extent in the major markets. Also in Chicago, you’ve got some new big office building projects going on. Retail is strong—I think we’ve got the lowest vacancy we’ve had since pre-recession.”
“Industrial is strong as well,” he continued. “Even hospitality is strong. There’s still, not so much in Chicago, constrain on supply in a lot of markets and financing, especially on hospitality, is still tough. Tougher than any of the other segments I mentioned. But I think for the right project, and the right sponsor, they are getting done.”
On the permanent debt market, especially CMBS, Bucaro noted that lenders are continuing to get more aggressive with their underwriting.
“One of the key metrics is what’s called a debt yield,” he said. “Which is basically the net operating income divided by the loan amount. Those continue to compress. When the CMBS markets first came back, the debt yields were in the 10% to 12 % range depending on property type, now they are in the 8% to 10% range. There are also more mezzanine debt lenders coming into the market, which is giving borrowers the opportunity to borrow more money. I’m not saying that’s good, but that’s where the trend is going.”
“There are continually new CMBS lenders entering into the market,” Bucaro added. “They’re all fighting for market share, and they’re starting to really undercut each other to win the deal. That’s a big benefit to the borrower because they’re getting some of the best pricing that they have been able to get in 50 years.”