Commercial Real Estate's Status, $10MM is the New $100M, Part 2

In continuing our discussion from Commercial Real Estate's Status, $10MM is the New $100M, Part 1:

Regarding Institutional Investors

• Most of them were out of the market for the past 3-4 years because there was an excessive amount of capital in play, driving terms below what was considered reasonable.
• There were only willing to consider Credit Tenant transactions - true Investment Grade Tenants, signed to a lease of 15 years or greater, on an Absolute Net basis, with pricing based on the spreads displayed in the corporate bond market.
• While corporate credit is key, real estate fundamentals must be present: Market rents, market pricing for $/sf of building, etc. Mentioned that they were very inactive and stressed that credit is everything in their underwriting.
• There is a large amount of uncertainty over the implied pricing of a large transaction in today's market, thus funding a deal over $50MM requires an "act of god."

Comments on the Private Market

• An investor's decision-making process focuses on underwriting real estate as the primary driver, including an understanding of market rental rates, reasonable building and land costs, and reasonable re-tenanting for alternative use.
• The large premium for purchasing a real estate asset that includes an income stream has been largely eroded.
• The days of purchasing retail bank branches paying $80/sf in rent when market is $20/sf are over.
• Private market players generally have a depository relationship with a local lender that is still providing relatively aggressive loan terms, although it is full recourse.

What are the New Realities of Debt Financing?

• The Commercial Mortgage Backed Securities (CMBS) market is flawed.
• The world as a whole is over-leveraged
• A borrower will have to pay a significant premium over an "A" product to get non-recourse.
• Current rates vary between 5% to mid 6% for recourse money but some lenders will do non-recourse at low leverage at roughly 7%+.
• If the CMBS market comes back, the syndicating bank will have to remain in the deal potentially holding as much as 20-30% of the paper.
• As an alternative to the CMBS market, lenders and capital sources are actively working on a solution but it will take some time to form a new and proven product.

What Deal Criteria Would Financial Institutions Presently Pursue?

• A $60MM deal for an "A" rated tenant will require 4 separate lenders to fund the transaction.
• A True Credit Tenant Lease deal on a Sale-Leaseback or Build-to-Suit terms.
• The building would need a true Credit Tenant, with 15+ year NNN lease through either a Build-to-suit or Sale-leaseback transaction.
• Alternatively, a strong credit-tenant with strong real estate fundamentals on a basic 70% LTV transaction.

Part 3 will cover Net Leases, Medical Office, underwriting credit, tenant retention strategies, and will summarize the status of the commercial real estate. Stay tuned!

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