- change ups
Commercial real estate financing opportunities scarce
"Oh my gosh, it's vastly different," he said. "In today's environment, it is nearly impossible to get a project financed. Speculative projects are completely off the table — it's not even worth bringing that to a lender."
Levitt is one of the founders of Third Coast Development Partners LLC, a Grand Rapids-based real estate development company known for a number of distinctive projects in West Michigan, including the Mid Towne Village project on the Medical Mile.
"For any business that has had a huge exposure to real estate, like developers and others, their risk has considerably gone up in the eyes of the banks, and therefore, they are unable to get loans. Or if they do receive loans, they are being charged a significant premium," said Sridhar Sundaram, chair of the finance department at Seidman College of Business at GVSU.
"There are a number of banks that basically aren't even in the lending business any more," stated Levitt.
Jonathan Rooks, principal of Parkland Properties, which owns commercial/residential real estate in several West Michigan communities, said the people who should not have been able to get loans a few years ago "are absolutely unable to get loans today. That part is good."
He added that developers that qualified for loans a few years ago "can still get loans today, but with more conditions."
"The only complaint I have are the banks' spreads," said Rooks, an issue also raised by Levitt. "The difference between the banks' cost of money and what they charge the customer (in interest) has gone up as a result of the people who shouldn’t have been able to borrow the money five years ago and didn’t repay their loan," said Rooks.
"I believe the good borrowers are being penalized by higher rates than they would normally have to pay, because of bad borrowers or bad lending practices in the past."
Commercial banks are one of three main sources of capital for commercial real estate development and multi-family residential developments, according to Harvey Greemann of Greemann Capital, a Grand Rapids firm that has been in the commercial mortgage business since 1973.
The total size of the U.S. capital market for commercial real estate and multi-family residential developments is about $3.5 trillion, said Greemann. The 8,500 commercial banks in the U.S. have traditionally had the largest share of that — 44 percent — while the second largest share came from the commercial mortgage-backed securities industry (CMBS) with 21 percent of the outstanding debt market. The third largest share was held by the life insurance industry, equal to about 9 percent of the pie, or roughly $320 billion. Greemann said most of his deals are with life insurance companies, of which there are a total of about 50 or 60.
"Most of those CMBS lenders are out of business. They just closed the doors and all the people are gone," said Greemann.
"The yields the bond buyers require are so high that nobody will borrow at those rates," said Greemann.
Some of the commercial banks "probably" are still loaning money to developers — "for the right deals," added Greemann, "but the world has changed in the last two years."
"A lot of banks borrowed money beyond their deposits," said Greemann. When bank losses began mounting, many found themselves below or dangerously close to their minimum reserves required by federal regulations, so they had to cut back on their lending just to hang on to enough cash to meet minimum reserve requirements.
The life insurance companies have cut back, but they are still doing business, he said, although he noted that the ones that borrowed money to loan out, such as AIG, are now out of business.
The CMBS companies would go 80 percent of the loan value, lower cap rates than other lenders, with much longer amortization periods. Greemann said those were "attractive deals on the surface, but they didn't hold up" — because the perception of real estate values changed dramatically.
Two years ago, cap rates were below 8 percent, but today they are closer to 9 percent for top quality A properties, he said.
Commercial property values in the U.S. today are still about 36 percent below the peak in 2007, according to recent reports from Wall Street. Mortgage losses forced banks to restrict lending, then real estate sales stalled as potential buyers began waiting for defaults by investors who had borrowed too much to buy properties between 2005 and 2007, hoping to resell quickly at a higher price.
Capital for real estate development "is severely limited. … It requires more equity today to do deals than it did two years ago," said Greemann.
Levitt said that when going to a commercial bank now for loans, the developers have to have reputable tenants for the proposed project already lined up with solid, long-term leases in place, and the project has to have a high debt coverage ratio. That is a measure of the monthly cash flow the project is expected to generate above and beyond its debt and other expenses. Levitt said a debt-to-income ratio of 1.1 was typical, meaning the borrower would have a regular cash flow at least 10 percent higher than the loan payment, after all other expenses were covered.
"Now what they are saying, typically, is a ratio of 1.3 is the starting range," said Levitt.
"The other thing that has changed radically is the loan-to-value," said Levitt. "They used to say, 'Well, we'll loan you between 75 to 85 percent of the value of the building.' Now they're saying 65 to 70 percent. On a million dollar building, that means that you now have to come up with between a hundred and two hundred thousand more than you used to."
"There are a number of banks that basically aren’t even in the lending business any more," he said. "Most of the people who did a lot of the commercial real estate lending in the past in West Michigan are not actually lending money."
"They may be telling you something different, but the fact is that even if you bring something to them within the criteria — solid tenants, 1.3 debt ratio, 70 percent loan to value — they're still going to say no."
Levitt said banks will claim "we don't have bad stuff in our portfolio. The other guys have really bad stuff but we don't have anything,'" he said, with a laugh. "The other thing you'll hear from banks is that for selective deals, 'we'll do stuff' — and it really isn't a lot," he said.
Banks will also state that they are making loans, "but they consider the rollover of an existing loan a new loan," he said.
The Business Journal recently received a press release from JPMorgan Chase Bank in Detroit, stating that it made approximately $1.5 billion in loans and lines of credit to nearly 1,600 small and medium-sized Michigan businesses during the second quarter, an increase of more than 40 percent from the first quarter.
In conversation with the Business Journal, Chase spokesperson Mary Kay Bean was careful to note that "some of this also would be renewals of credit. It's both new and renewal. But they're both good signs, right? Because they show that people are doing things."
According to Levitt, renewals were routine before the economic meltdown. Business loans are typically for a period of one or two years; a few years ago they were often three or four years.
"And everyone knew you weren't going to pay it off" when it came due, he said. "You were going to refinance it.
"Now they look at you like you're some kind of goofball" when the borrower asks the bank to renew a loan, said Levitt. He added that the reply is, "Oh no, it's time to pay us off."
Third Coast "is doing as good as one can do in this environment," said Levitt. "We are surviving. We are still doing projects. We understand there is a new set of rules, and we are working through those."
However, there is far less development right now, he said. "It's just not possible to do the type of development that you would have done two, three, four, five years ago. And anybody who tells you otherwise is not being truthful."
Third Coast is "using some traditional lending sources and we're now starting to look at less traditional lending sources," Levitt said. Sometimes that means seller financing, "sometimes it's Dutch uncles," he said, with a laugh.
Third Coast closed a couple of deals this year, he said, although he didn't want to reveal details about those yet.
And Third Coast has "moved some borrowing into longer term loans," said Levitt.
The banking industry is like a pendulum, he said, explaining that some developers remember similar situations in the 1980s and 1990s related to the savings and loan crisis, and then a little later with a currency crisis in Asia.
"I think what happens is, money gets very tight," he said, and then "it slowly loosens up over time."
"I don't think, in the commercial construction/real estate development business, that we're going to see the turnaround until the middle of next year — and if lending doesn't free up, that's the earliest we're going to see it."
Levitt said he is not suggesting that "we go back to irresponsible lending."
"We've gone from irresponsible lending to responsible non-lending. The pendulum needs to swing to responsible lending," he said. "Do due diligence, make sure the person can pay it back, try to stay away from frothy deals."