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Posts from April, 2011

CRE Private Lending - A Performance Based Industry

Wednesday, March 30

People from New Jersey sometimes have a unique way of getting their point across. In the commercial real estate and finance business, individuals are gruff and take crap from no one.

I grew up in Woodbridge, NJ, which is about 30 minutes by train to NYC. When my Mom was walking out the door, if we asked where she was going, her response was typically something like, “Up the pig’s ass for a ham sandwich. You wanna come?” I miss my Mom, she had a great way of getting her point across.

Negotiating is an Art

I recently had a conversation with Mike Paff, a real estate broker in the Northern NJ and New York City Metro area. Mike is has a wealth of experience and an excellent grasp of his market. We discussed the lending business and how all the players take a position and are not willing to budge. Buyer’s brokers end up contacting everyone they know to get the same answers. Some lenders will scrutinize a $10 million loan more than a $100 million loan with lower ROI. It is difficult to understand their position because they don’t publish their criteria. It’s all about negotiating and not losing your position because you overlooked some important information. According to Mike, “in the process of negotiating commercial real estate, everybody must be willing to lose the same number of fingers.”

It must be tough to be a piano playing CRE Broker in Jersey.

The negotiating process also means the parties must perform. We all want deals to close with everyone walking away a winner. To achieve success in a deal that works for everyone, there must be balance. Like a marriage in Utah, all parties must compromise. There are several parties in a CRE deal, so communication and management of information is crucial. Typically a deal can have a 6 or 8 interested parties:  the buyer, other guarantors, his real estate agent, the agent’s broker, the loan broker, the lender’s agent, the loan officer, and the bank or private lender. Sometimes borrowers put themselves in a position that requires a brokers’ chain, because of a weak deal.

Performance of the Buyer

There are many types of investors in the real estate industry. Some have started out in residential and moved into commercial others may have moved from other investment categories.  Then there are speculators, no-money-downers, non-profits, builders, and those looking to use the IRS 1031 exchange program work to their advantage. All of whom have different objectives, so they focus on what is needed to meet those objectives. A problem with buyers sometimes is that they lack expertise to make their loan presentable to a bank or private lender. Be prepared is the motto of the Boy Scouts of America. You expect your kid to do his homework and be prepared. That’s all lenders ask of borrowers. You are asking for money, so tell the lender why you are trustworthy, your credit score, how you will pay it back, what the property is worth, how much you want, why you want it, and what’s in it for the lender. The buyers’ digit is their cash down payment and/or equity. The lender wants your financial commitment.

Performance of the Buyer’s Broker

In commercial real estate buyers hire brokers to perform two functions – find a property and get funding for the project. This means they are taking the buyer’s position in terms of preparing documents, business plans, proforma sheets, and marketing materials. Many times the CRE Broker finds the property and a Commercial Loan Broker does the rest. They understand the CRE industry, lending, and the language of the lenders. Advice to these professionals – sit on the other side of the desk. Ask yourself, “Would you fund this?” Your link to the lender may be a loan officer or an agent for a private lender. They are the gatekeeper. They want to make the deal happen, but don’t want to lose their job and credibility in the process. The broker must make the numbers work for the lender and do their best to show risk, not hide it. What digits must they give up? Work hard for your client’s interest.  That means telling them the hard truth about a project that they may be emotionally invested in.

Performance of the Lender’s Agent or Loan Officer

Private lenders have an agent working for them to go out and find the deals. That means the agent get paid by the deals that close. Simple! Or is it? The agent is always in a tough spot, stepping on the gas and brake at the same time. The agent wants the buyer to get his loan but must take the position of the lender. His/her skill-set is constantly growing as he/she must establish expertise to make a variety of deals work and maintain credibility in the industry. Most of the applications submitted are scrutinized and never close. The buyer learns more about his position and adjusts his deal so it works with another lender. Someone else gets the deal, most likely with the same private lender, and the agent gets to go to stress therapy. In this business you must constantly adjust your attitude to remain positive. The agent’s digits are based on communication and humility.

Performance of the Lender

Consider yourself a lender. You have all this money that you want to work for you. The fact is the world is filled with greedy [insert cuss word here] who want to scam you for your money. That’s what most of us think about banks and private lenders. The truth is, they are in business to invest money and want to make loans with legitimate businesses. That means they must perform internally to their constituency and perform externally to protect their position. There is no room for emotion in this business, any doubt results in, “no, next file.”  Performance here is the ability to underwrite and fund in a timely manner. The lender’s digits are based on the amount of work and expense that goes into their process before the loan funds. Other parties can get emotional and walk away during the process.

The Stars Must Align

This process conjures up the image of a gangster movie. A meeting in the back of an Italian restaurant in Brooklyn, a thick neck guy named Nick, a pair of wire cutters, and fingers laying on the table.  It’s not that bad really; they can’t cut off your fingers if you’re telecommuting.

The process requires a huge effort and compromise from all parties. Having perspective by working in different areas at different points of your career also helps. If the economics conditions are right, the borrower is strong, and the risk is understood, then things are likely to go well… as long as the players don’t get emotional.

Andy Sabo is the President of TOP 10 Funding, LLC.

TOP 10 Funding represents private lenders with access to $400 Billion to lend for commercial real estate projects, such as multifamily, assisted living, and office building purchases and refinance, business financing, new developments and construction in most cities in the US.

We have great relationships with DIRECT lenders for Commercial Real Estate.

There are no up-front fees and the application process is simple and fast. An executive summary and a two-page application will get you an answer in a few days.

Phone:             (808) 375-4845       Email: [email protected] Website: top10funding.com Andy’s Blog: http://top10funding.com/blog LinkedIn: linkedin.com/in/andrewsabo Facebook: facebook.com/andy.sabo Twitter: @andysabo808

 

 


Investing in Multifamily Real Estate - Where's The Beef?

Thursday, March 24

Investing Multifamily Real Estate    

Where’s The Beef?         

I recently went to a networking meeting where a young real estate investor spent about thirty minutes talking about how investing in multifamily real estate is making him wealthier than he ever imagined. He claimed to get into the business with no cash using other people’s money (OPM). So why was he in a networking meeting trying to make connections? There’s a special place for people like that.

Is there money to be made in this area of real estate? Absolutely! To succeed you need what I like to call the 3 C’s and some B’s. Capital, Credibility, and Crystal Ball(s).

Capital – This is risky business. Lenders want a down payment of at least 20-30%. Depending upon your preferences and goals, current criteria generally seek cap rates of not less than 8% and “cash-on-cash” returns of not less than 12%, loan-to-value (LTV) ratios of 70% to 80% (depending upon whether recourse or non-recourse financing is used), and debt service coverage of at least 1.25. Banks are not excited about lending for commercial property these days, so the only option is private lending. Equity share in a property may be used as a contribution for down payment with some lenders, but these deals require that all the pieces fit together well. The consultants representing the buyers add a fee, they sometimes involve other consultants and you end up with a “broker’s chain” of fees that could end up with upwards of 23% APR or more on the loan.

Credibility – Okay, say a mechanical engineer just lost his or her job, and wants to buy an apartment building, fix it, flip it and make a huge profit. Engineers are smart, respected people. Multifamily RE investing is not like engineering; Real estate investing requires business savvy, and an understanding of finance, risk assessment, marketing, construction, and timing. Lenders lend to people with relevant experience. Conversely, a general contractor who knows how to renovate a building may not have the expertise to improve occupancy through management and marketing.

Crystal Ball(s) – The combination of being able to analyze market trends, economic forecasts, and being in the right place at the right time is important. If the property is bank-owned or priced under market, there is usually a good reason. Valuation of commercial property is based on cost and income. You must know about CAP rates, NOI, and have an ability to predict the future.  Having “skin in the game” as they say requires courage, backbone, guts. You need to be just like a financial gladiator, except without the lions and swords.  

The Mortgage Bankers Association (MBA) released its Commercial Real Estate/Multifamily Finance Quarterly Data Book for the third quarter of 2009. The data in this report reflects a negative outlook for multifamily apartment investments. Here are highlights from the report (www.mortgagebankers.org):

  • Vacancy rates rose in the third quarter for all major property types.
    • For apartment properties, vacancy rates rose from 6.5 percent in the third quarter of 2008 to 8.4 percent in the third quarter of 2009.
    • Industrial properties saw vacancy rates rise from 9.8 percent to 13.0 percent
    • office properties saw a rise from 16.0 percent to 19.4 percent and retail vacancies rose from 12.9 percent to 18.6 percent.
  • Asking rents have been falling –
    • 6 percent for apartments
    • 9 percent for industrial properties
    • 9 percent for office properties
    • 8 percent for retail properties
  • Property Sales and Construction activity have seen significant declines
    • Year-to-date property sales in 2009, through 3rd quarter, were 72 percent lower than the same time in 2008, which was 66 percent lower than they had been in 2007.
    • Every major property type was affected
    • Sales volume is so low it is hard to gauge commercial property prices but the Moody’s/REAL index showed an 11.5 percent drop over the quarter.
    • New construction activity has slowed to a crawl. Nationwide construction was started on only 5,000 units in multifamily housing in October – the lowest level ever. Given market fundamentals and pricing it is unlikely we will see a significant rebound any time soon

Another analyst has a different story. The CoStar Group (www.costar.com) reports “U.S. Multifamily Market Strengthens in Third Quarter On Rising Demand, Falling Vacancy.”

  • The national vacancy rate compiled from the 54 largest markets tracked by CoStar declined for the third straight quarter in 2010, falling 20 basis points to 7.7%. The national rate was a record 8.4% at the end of 2009, rising 130 basis points over the course of last year.
  • The third quarter saw positive demand of around 47,000 additional units. Year to date, renters have absorbed about 140,000 units. In 2009, demand was a negative 60,000 units.
  • So far in 2010, 20 metros have recouped their total demand for apartments lost due to overbuilding and other factors during the real estate downturn and recession. There’s a wide disparity across the country in demand growth. However, metros grew an average of 1.3% in the first nine months of 2010. Four of the five markets where demand is rising the fastest are Sun Belt metros, including Charlotte, NC, which saw the strongest growth at 3.5%, followed by Raleigh-Durham, NC; Phoenix and Dallas/Ft. Worth. Richmond, VA, also saw strong demand, mostly as a result of realignment of military personnel.

So where is the beef?  Kiplinger (www.kiplinger.com) says the 10 best cities for prosperity, innovation, and jobs are:

  1. Austin, Texas
  2. Seattle, Washington
  3. Washington, DC
  4. Boulder, Colorado
  5. Salt Lake City, Utah
  6. Rochester, Minnesota
  7. Des Moines, Iowa
  8. Burlington, Vermont
  9. West Hartford, Connecticut
  10. Topeka, Kansas

The above cites will no doubt experience growth, but may not reflect a fertile ground for multifamily real estate investment. As local economies are declining, the foreclosure rates increase, as does the demand for rentals. At some point, when the economy improves, and the high paying job market stabilizes, renters will become home owners. The economic cycle requires understanding the demand window.

 

Andy Sabo is the President of TOP 10 Funding, LLC.

TOP 10 Funding represents private lenders with access to $400 Billion to lend for commercial real estate projects, such as multifamily, assisted living, and office building purchases and refinance, business financing, new developments and construction in most cities in the US.

We have great relationships with DIRECT lenders for Commercial Real Estate.

There are no up-front fees and the application process is simple and fast. An executive summary and a two-page application will get you an answer in a few days.

Phone:             (808) 375-4845       Email: [email protected] Website: top10funding.com Andy’s Blog: http://top10funding.com/blog LinkedIn: linkedin.com/in/andrewsabo Facebook: facebook.com/andy.sabo Twitter: @andysabo808

 

 


Commercial Real Estate - Best Hedge against Inflation

Wednesday, March 16

Commercial Real Estate – Best Hedge against Inflation
hedgeAccording to the National Real Estate Investor website, the outlook for real estate investments in 2011 is optimistic. “An improving economy combined with a thaw in the capital markets and limited new supply led to a big spike in investor confidence in the fourth quarter” nreionline.com .

 Commercial Real estate investment, like investments in commodities such as gold, oil and wheat, has traditionally offered and been regarded as one of the best hedges against inflation. Which is why real estate has traditionally been included in institutional portfolios. When you combine the hedge against inflation, with a favorable risk and return profile, real estate remains an excellent investment.

Value-Added investing

Investors are rolling up their sleeves and getting involved in property improvements, management, marketing. Added value means enhancing a product or service through time, sweat and/or money before offering that product for the use by a customer.

Value added investors is take something of less worth, improve it and sell it or generate income above the old value, plus the cost of renovation. Television shows like Flip this House  give us the impression that with a little elbow grease, any of us could add value and make profits. The reality of value added investing is much harder than the theory behind it. This best way to safely calculate whether a real estate asset is a good investment or not is by doing proper due diligence.

In commercial real estate, Net Operating Income, or NOI is the difference between gross income and operating expenditures. The very first thing a value added investor will be looking for is an NOI that has the potential to increase. It is important to understand NOI because all commercial real estate transactions depend on its value.

Value cannot be added unless the property needs improvement. Without an improvement need the asset is not a value added investment. Anything else would be considered to be opportunistic or stabilized investing. Stabilized investing is simply the exit strategy for value added investing. A stabilized loan is put in place once the improvement has been made. The goal is to refinance out all the equity with a permanent stabilized loan that cashes the investor out of a cash flowing asset.

Publicly traded securities and portfolio managers work to capture “the alpha”. By investing in an asset or through some index fund, the goal is to invest in assets with gains that outperform the market. Value-added investing is the quest to find something under-valued that has the potential to beat what is happening in the rest of the market.  Investors improve their position either by purchasing Bank-Owned (REO) properties below value or distressed properties with value-added potential. The owner/investor controls value by the work they perform on the asset, which can make the return more complex than simply increasing “alpha” defined for public securities portfolios.

Like all investments there is risk. The physical part of creating added value means understanding property management and dealing with developers or contractors. These risks could be categorized as Property Risks.

Construction Risk – there is an over abundance of construction risks in any project from errors in construction, strikes by employees, materials shortages, price changes and all other delays.

Environmental Risk – local, national or international economic changes and building cycles.

Joint Venture Partner Risk – having to deal with another company invested in the project brings in a whole new dynamic. Too many problems to discuss in this article but they can range from business philosophy to hands on implementation.

 Leasing Strategy Risk – vacancy changes due to changes in the leasing strategy of a building.

Liquidity Risk – cash is king and the lack of money can make it increasingly hard to find a partner to help finish a project.

Market Analysis Risk – architectural design of development or re-development of buildings can have a dramatic effect on real estate value.

Macro Risks or broad market trends can affect the returns from a property.  The following risks fall into this group.

Benchmarks – this is a new field which is strongly correlated to the new use of derivatives in the real estate market. There are few useful tools in this area as most markets are highly dependent on local economics.

Capital Market Cycles – this is the risk involved in investor’s preference for certain types of real estate. Depending on the asset class the real estate is grouped, there could be great differences in the performance of properties in an asset class.

Demographic Trends – these are the aspects that deal with the changes or lack thereof the population for a given region or nation. They can have a profound effect on long term returns especially for different property types. A prominent example is the growing population of Baby-Boomers, in need of Senior-Living or Care Homes.

Leverage – this is the debt to equity ratio used in real estate transactions. High leverage is a situation where there is very little equity and lots of debt, and low leverage couples lots of equity with low debt. Investors want projects with least amount of equity placed in the project which in-turn raises the potential return and the risk or volatility. If projects are highly leveraged and property values drop, developers or property owners can find themselves upside-down.

Manager Incentive Risk – this is the risk associated with the managers desire to over perform by selecting properties to produce results well above the target for excess performance based fees.  This risk in not isolated to real estate investing, however it should be evaluated.

Real Estate Cycles, Interest Rate Cycles, Inflation Cycles, and Business Cycles – all of these have an effect on all asset classes of real estate and the returns from real estate investments.

Activities and risks taken to outperform the market average can be categorized as Market Risks. Some of this is speculative because one could underweight or overweight property return projections based on future expectations.

Enterprise Risk – this is the risk associated with investing in any given group. Many times when a group over-performs it will venture into more risky territory because of the lure of great financial returns, This resulted in the mortgage meltdown.

Metro Area Allocation Risk – these risks assume the differences in cities impact the returns on a property. For instance there can be differences in similar properties depending on economic drivers in a metro area. Economic growth, easy access to building permits and land entitlements, or dependence on a specific sector of business are some examples.

Property Selection – There can be significant differences in the performance of properties based on location within a defined region.

Property-Type Allocation Risk – even though all property types offer comparable returns to one another, the performance of those property types is considerable. For instance office properties are more volatile than apartments.

Reinvestment Risk – this is simply the process of taking the good returns from one property and placing them in a satisfactory property. 1031 Exchanges are very popular to avoid paying capital gains taxes but investors must be weary of reinvesting in properties just for the tax benefit.

Property Risks  are the set of risks is associated with active property management. This is of particular relevance to value-added investing, especially when there is a need for re-development or even ground-up new development.

Construction Risk – there is an over abundance of construction risks in any project from errors in construction, strikes by employees, materials shortages, price changes and all other delays.

Environmental Risk – local, national or international economic changes and building cycles.

Joint Venture Partner Risk – having to deal with another company invested in the project brings in a whole new dynamic.  Issues can range from business philosophy to hands on implementation.

Leasing Strategy Risk – vacancy changes due to changes in the leasing strategy of a building.

Liquidity Risk – cash is king and the lack of money can make it increasingly hard to find a partner to help finish a project.

Market Analysis Risk – architectural design of development or re-development of buildings can have a dramatic effect on real estate value.

In value-added investing, the risks most associated with returns that will increase NOI for a project might be:

  • Leverage
  • Reinvestment
  • Capital market cycles
  • Enterprise risks
  • Property risks.

An investor or manager should consider these actions to improve NOI on a particular project:

  • Re-tenanting – this may include increasing occupancy, increasing the lease rate, increasing lease term or increasing tenant credit.
  • Rehabilitating the asset should lead to increased demand, higher occupancy, higher lease rate, longer lease terms and better tenant credit as well.
  • Repositioning the asset or changing the assets use can add significant value to an asset. As well as significant changes in the submarket such as roads, new employment centers and large scale mixed use developments can increase NOI.

Keep in mind, however, that these revenue generating activities are subject to the risks associated with value-added investing discussed earlier. Even though applying any one or several revenue generating events to an asset should in theory drive value up, all real estate investing works within the constraints of the risks associated with the asset at hand.

Residential versus Commercial

Residential real estate is a completely different animal than commercial investment. Residential property values are determined by the market supply and demand, and may be influenced by subjective opinions. Some people like city views, others like ocean views. In residential real estate, comparable properties are used to determine value, whereas in commercial real estate, the value is based on Cost, Income, and CAP Rate.

An expert in the industry recently told me that it’s simple math. The numbers need to work. This may be true, but there’s more than that. You need to understand the real value and research, research, research!  There is a reason that the property fell in disarray. Understand the community before buying a property there. There may be undisclosed reasons for the low property values, such as environmental, economic, social, or other factors.

Also, every deal has its own merits and its own perils. In all deals there are usually one or two main events, whether risks or rewards, that need to be managed properly to drive the exit NOI. Know what those main events will be and plan for every situation that may arise during that phase of the project cycle. Then after planning think of a back-up plan as well.

Don’t believe the seller’s numbers. Audit the property and get a Broker Price Opinion (BPO) on the value.  Every good real estate transaction will have due-diligence with a Business Plan in order to make an informed decision. Such as: capital structure outline (debt and equity investments), sources and uses of that capital, the capital improvement, any historical data on the real estate involved, all tenant information, the project Pro-forma, and lastly the exit value (Stabilized NOI/Exit Cap Rate).

 

Andy Sabo is the President of TOP 10 Funding, LLC.

TOP 10 Funding represents private lenders with access to $400 Billion to lend for commercial real estate projects, such as multifamily, assisted living, and office building purchases and refinance, business financing, new developments and construction in most cities in the US.

We have great relationships with DIRECT lenders for Commercial Real Estate.

There are no up-front fees and the application process is simple and fast. An executive summary and a two-page application will get you an answer in a few days.

Phone:             (808) 375-4845       Email: [email protected] Website: top10funding.com Andy’s Blog: http://top10funding.com/blog LinkedIn: linkedin.com/in/andrewsabo Facebook: facebook.com/andy.sabo Twitter: @andysabo808