Archives for November 2017

As banks have pulled back from construction financing, alternative lenders are finding fertile ground there. Walker & Dunlop’s Jamie Butler takes us on a tour of the landscape.
“It’s a pretty diverse field of capital sources for what is really a narrow field of opportunities:,” says Butler.
In the years following the Great Recession, banks represented the lion’s share of construction financing, typically providing loans for near-total construction costs at a relatively cheap rate of 2.50% on top of LIBOR. Now, amid changes in regulations, banks have tightened up on leverage—instead of 75% to 80%, leverage has dropped to about 65%–and developers are paying almost twice the previous interest rate due to rising spreads and increase to the LIBOR index.
The new, more conservative approach to bank financing has caused loans to become smaller and more expensive than before. This has brought a wide array of alternative lending sources into the construction financing arena. With that expanded compass of choices, borrowers also need increased levels of guidance in selecting the source, and solution, that best meets their needs. Jamie Butler, managing director of Walker & Dunlop, spoke with GlobeSt.com on navigating this new lending landscape.
GlobeSt.com: Across most sectors, we’ve seen a ramp-up in construction activity but at the same time we hear that there’s a pullback as far as lenders are concerned. Is there a disconnect between the lender’s viewpoint and commercial real estate fundamentals?
Jamie Butler: Rather than it being a disconnect, I think there’s been more of a massive shift on the commercial lending side that has occurred independently of commercial real estate fundamentals. That shift has been driven by regulation and by consolidation—of banks, especially. The amount of liquidity that’s required today of banks to make the same level of construction loans they were making just four or five years ago is a substantial barrier to increasing, or even maintaining, historical loan volumes. Bank consolidation has compounded the issue by reducing the amount of local and regional options for borrowers, especially in the construction lending space.
The fundamentals are still very strong, largely because we’ve had a very consistent real estate cycle for the past seven years. The landscape of commercial real estate in most markets is as strong as it’s ever been. The result is that a gap has developed between demand for construction in many markets and the  ability for traditional construction lending sources to keep pace.. As that gap has widened, we have seen a flood of alternative construction lending sources looking to meet the demand. These sources include debt funds, overseas banks, private equity and pension funds attracted to the risk adjusted returns of construction financing.
Over the past five years, this has become a much larger share of our lending market, and those lenders don’t have the same requirements and hurdles as traditional construction lenders. They’re largely unregulated, they largely control their own liquidity amounts, they’re not told what they have to hold on balance sheet and in most cases, they have a heritage in real estate. Many have an equity side to their business or they hold real estate themselves, so unlike a commercial bank, where their primary business is either retail banking or investment banking, the non-regulated lenders of today are well-versed in real estate. As a result, it makes for a good, user-friendly option for most of our borrowers.
GlobeSt.com: When banks do make loans, what are the underwriting criteria in which they’d be more conservative compared to a few years ago? Loan-to-value ratios obviously have gotten tighter.
Butler: Loan to value and loan to costs are always good metrics, and those have probably come down by about 10% over the past few years. In terms of the underwriting, though, the lenders are constantly aware of underwriting to an exit that increasingly is unknown. It was as unknown five years ago as it is today, but now, since we’ve been in such a low interest rate environment, most lenders are underwriting with more conviction to an exiting in a higher interest rate. This has a direct impact on proceeds via debt service coverage tests and exit cap rates. In the case of multifamily, the underwriting is somewhat easier, because you have entities that are providing debt more consistently, such as Fannie Mae and Freddie Mac. However, on the office, retail, and other commercial asset classes, there’s not as obvious a consistent source of takeout for the construction debt. It ebbs and flows with the CMBS market, life companies and so on. The result is a much more conservative sizing of these loans.
GlobeSt.com: Even as non-traditional lenders are more willing or more disposed to make construction loans, are they also becoming more conservative in their underwriting?
Butler: In some cases, they are. In some cases, they’re looking very much like a traditional bank lender. That’s happening in large part because more core capital—which is cheaper capital and likes to have safer money—is moving into that debt space. As a result, it’s not unusual to get quotes back from a bank, a debt fund, some private equity and some pension funds and have them look, at least on the margins, pretty similar to one another.
There are opportunistic lenders out there who are always looking for a much higher yield and therefore a higher risk. I don’t think they’re becoming more conservative; what’s happening is that there was not a very good middle tier of lender between a bank and an opportunistic fund. Now you’re starting to see that get filled up and starting to push much more toward the traditional bank execution in the economics than the opportunistic funds.
GlobeSt.com: Walker & Dunlop not only looks across a number of capital sources, but also considers a number of different potential solutions. How does this play out for clients?
Butler: By way of example, last year we closed loans with over 150 individual capital sources. That’s a wide spectrum, and includes local, regional and national banks, life companies, pension plans, international banks, private equity, debt funds. It’s a pretty diverse field of capital sources for what is really a narrow field of opportunities: construction loans, largely on multifamily but not exclusively. Our role is to really know every one of them, so we can be sure we are connecting them to the right opportunities on behalf of our clients.
By the same token, it also makes it more difficult than ever for an owner or borrower to have visibility to all of their options and understand which one is best for them. The variety is almost overwhelming. We’re able to synthesize down from that very large bucket of capital sources to the very best for their particular transaction.
We keep our pulse on that because these lenders, especially the alternative ones, do change course in terms of what they’re looking for both in economics and in product type from year to year and sometimes within a particular calendar year based on their investors demands. It’s our job to understand the direction and flow of that capital at all times.
GlobeSt.com: Is keeping your finger on the pulse more important now than ever?
Butler: Absolutely. I would venture to say that it’s not even the same game anymore as it was five years ago. There’s a much wider array of options, and so you need someone who is focused on that market every day to understand what the array is, and where a particular project falls within that spectrum.\
By: Paul Bubny (GlobeSt)
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Connectivity becomes the main priority when office tenants are weighing their future space needs, according to a survey conducted by WiredScore and Radius Global Market Research.
Barendrecht: “Tenants want an assurance that their building’s infrastructure will meets their connectivity needs” in the near term and the future.
When weighing a decision on space, the top two considerations are location and price. True or false? Only partly true. After location, the second most important factor in a tenant’s current space, according to a study by Radius Global Market Research and WiredScore, is the quality of Internet connectivity. When it comes to evaluating future space needs, connectivity takes pride of place, with price and location ranked second and third in priority.
Connectivity isn’t something leasing decision makers take for granted; in fact, many find that they can’t make this assumption. Eighty percent of the leasing decision makers surveyed by Radius and WiredScore—who included chief executives, heads of real estate and facilities professionals—reported having problems with their office Internet connections.
Disruptions in connectivity occur an average of once per week, according to survey results, and 77% of the respondents said these outages hurt profitability. In terms of the effects of outages on a company’s employees, increased stress level was cited by 45% of survey respondents, followed by frustration in helping customers (41%) and lower productivity (36%).
Titled The Value of Connectivity: What’s the Cost of Poor Digital Connectivity for Commercial Real Estate, the survey shows that about the same proportion of tenants (77%) feel that the leasing process would go more quickly if they knew the property was Wired Certified in accordance with the rating system developed by WiredScore. In addition, if an owner could prove a building’s reliable connectivity, better than four out of five tenants (84%) would pay more per square foot for their space.
Drilling down into specific capabilities, connectivity factors that would lead tenants to pay higher rents include technology in place to improve mobile coverage and reception (77% of respondents), speed/bandwidth (75%), redundancy (73%), resiliency (73%), reduced set-up time (71%) and cost (70%). Ironically, 63% of survey respondents said it’s difficult to get information about a space’s connectivity when they’re negotiating a lease.
That’s not an idle complaint: 91% of survey respondents said that a lack of reliable internet connectivity would affect their rental decision. And 51% said they wouldn’t consider renting office space at all if they knew it possessed poor connectivity infrastructure and would, in fact, limit their search to Wired Certified buildings.
“Tenants want an assurance that their building’s infrastructure will meets their connectivity needs in the immediate, but also in the future, regardless of whatever technological leaps are in store for their business down the road,” says Arie Barendrecht, WiredScore’s founder and CEO. “Landlords can provide the level of transparency that tenants are seeking though an independent assessment of a building’s technological infrastructure, which we now know increases initial leasing interest and prompts tenants to sign faster and pay more.”
This survey was conducted online in August among 150 office tenants defined as having at least some decision in leasing decisions. Markets covered by the survey included New York City; Los Angeles; Chicago; Philadelphia; Dallas/ Fort Worth; the San Francisco Bay Area; Washington, DC; Houston; Boston; and Atlanta.
By: Paul Bubny (GlobeSt)
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Tenant improvement allowances and free rent are up nationwide and growing at a more rapid pace, and there’s been a real slowdown in velocity despite ample capital in the market, Colliers’ Scott Latham and Andrew Nelson tell GlobeSt.com.

Tenant improvement (TI) allowances and free rent are up nationwide and growing at a more rapid pace, and there’s been a significant slowdown in velocity despite ample capital in the market, Scott Latham, vice chairman and co-lead for Colliers International’s New York capital markets and investment services, and Andrew Nelson, the firm’s chief economist, tell GlobeSt.com. As 2017 draws to a close, we spoke with Latham and Nelson about current CRE investment trends, both on a national and global level, and the role of rising interest rates in investor strategy for 2018.
One overarching trend Latham notes is the increasing cost of attracting and retaining tenants. “Tenant improvement allowances and free rent are up about 70% in midtown Manhattan over the last five years, which equates to $65 per square foot in TI allowances and eight months of free rents,” he says. While those are approximations and each transaction is different, it is getting more expensive for landlords to both attract tenants seeking space and retain the tenants they already have.
From an investment-sales perspective, there has been a real slowdown in transaction velocity, according to Latham. Year-over-year, high-level activity is down 50% in Manhattan and about 19% nationally. “It’s not that there’s any shortage of capital, but there simply hasn’t been a lot of trading activity this year,” he says. In Manhattan, this trend is particularly pronounced because of $160 billion of Manhattan real estate has sold since 2014.
But that’s not the only reason for the slowdown, says Latham. “Some things happened last year that started to create uncertainty in the minds of investors, and as a result investors started to be more cautious and be a little more cautious.” The first factor was Brexit, and uncertainty over how it would impact the European markets and what it would do to the markets in general. This created a situation where transactional activity slowed in Europe and in the US. Second, the US elections produced uncertainty on the part of real estate owners and investors.  That uncertainty has continued because of proposed tax cuts. “They don’t want to transact now if taxes are going to be reduced shortly.”
Nelson: “Globally, the big news of the summer was China’s announcement that offshore investment will receive greater scrutiny from Beijing, likely reducing direct acquisitions from Chinese entities, particularly for big-dollar properties.”
The third factor influencing the Manhattan marketplace, in particular, is cap rates, which have started to plateau after a number of years of cap rate compression. “We’ve seen cap rates begin to stabilize, which is not terribly surprising in a mature part of the market cycle,” says Latham. “People stop underwriting growth as they do in the early part of a cycle.”
While property transaction volumes are continuing to trend down, price appreciation is generally remaining moderate, says Nelson. “This is consistent with our conclusion that we are nearing the end of this real estate market’s cycle.”
As a whole, the US economy is still viewed as strong and stable, Nelson says, which—combined with ultra-low interest rates—makes US commercial real estate an appealing investment, notwithstanding the Fed’s continued slow push to higher interest rates.
There is at least one caveat to this rosy picture, however. “Globally, the big news of the summer was China’s announcement that offshore investment will receive greater scrutiny from Beijing, likely reducing direct acquisitions from Chinese entities, particularly for big-dollar properties,” says Nelson. But, he adds, impacts from any Chinese pullback are likely to be relatively limited and focused on a few key markets.
As foreign investors go, Latham says that in 2016, two of the top 10 most active participants in the entire US sales market were Chinese and one was Canadian, and those three accounted for about 15% of the activity. In the US market this year, there were no Chinese investors in the list of top 10 most-active investors in the market from a dollar perspective. However, there were three foreign buyers in the top 10 this year: the government of Singapore, Case (a Canadian company, and historically Canada has been the steadiest foreign capital provider to the US market) and APG Dutch, a pension fund. Those three foreign buyers account for about 34% of the market activity.
“We continue to see a large influx of foreign capital in spite of the fact that Chinese capital for the last half of 2017 has been largely absent due to the Chinese government’s focus on capital controls,” says Latham. There has been a lot of foreign activity—this market cycle we have a seen true globalization of the real estate industry—and investors are more comfortable now scouring various markets around the world as they make their investment decisions while factoring in stability, rule of law and other factors as they attempt to balance risk with reward.
For both foreign and domestic investors, interest rates are playing a role in their strategies, but not an outsized role. Latham says there is an overwhelming sentiment that the rise in interest rates will be slow and moderated by future growth. “Rising interest rates mean we’re in a growing economy,” he says. “This translates to tenants feeling good about the way things are going. ” He says when tenants feel this way, they tend to grow and expand, which are good things for the real estate sector.
Of course, a rise in interest rates could slightly lower returns, but investors tend to “price in” those interest rates, and higher rates point to a stronger dollar, which bodes well for foreign investors who hedge against it or rise against their own currencies, says Latham.
Another factor related to the rising interest rate environment is the refinancing risk for those who have loans coming due. This remains in the borrowers’ favor. “Most real estate deals are either five-year or 10-year money,” says Latham. “Interest rates are now 75 bps less than five years ago and 275 bps less than 10 years ago, and values have appreciated.”
On balance, the market is very healthy and has done a very good job of maintaining some serious discipline this time around that will prevent the type of correction we saw in the last cycle, where things were out of control, says Latham. “There’s modest leverage, a strengthening economy and currency that will strengthen as rates tick up a bit. Smooth sailing for at least some period of time is expected as the economy continues to improve in the US.”
By: Carrie Rossenfeld (GlobeSt)
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