Our sister publication, GlobeSt.com, covers one of the engines that keeps life and annuity issuers running: the commercial real estate market. Life insurers participate in that market by renting space, owning buildings, lending directly to development companies, investing in mortgage-backed securities, and participating in mortgage-related derivatives markets.
Kelsi Maree Borland recently talked to players in a corner of California commercial real estate market. Here is a version of an article that ran on GlobeSt.com March 23.
“Today’s market is nearly unrecognizable from a year ago,” John Marshall and Joe Giordani, VPs at Northmarq Capital, say about the bridge lending market. The duo recently funded a $33.9 million bridge loan for an office redevelopment project of 1, 3, 5, 7, 9 Corporate Park in Irvine, California, on behalf of borrower Kelemen Caamano Investments.
The deal received interest from life insurance companies and pension funds to debt funds and banks as well as non-bank lenders, which the borrower ultimately chose for the deal.
Marshall and Giordani say that the bridge lending market has taken off in the last 18 months, and office redevelopment projects are an attractive deal for the group. We sat down with Marshall and Giordani to talk about the demand for office redevelopment projects, this recent deal, and how the bridge lending market has changed.
GlobeSt.com: You were able to identify several lending groups for this project. In general, what is lender demand/appetite like for redevelopment office projects in Orange County?
Joe Giordani: Even with rising interest rates, there is so much global capital chasing yield that bridge pricing and liquidity has become extremely aggressive in the past 18 months. Today’s market is nearly unrecognizable from a year ago, with a number of new bridge lenders that have popped up. All of these lenders need to write loans, and don’t have the luxury of waiting.
Marshall: Both lenders and investors continue to go long on diversified coastal office markets with a high quality of life and an educated workforce, assuming that employee lifestyle preferences and low unemployment will continue to drive demand. Bridge lenders of all stripes feel good about downside risk—especially with the affordability of Class B product compared to creative and concierge office in Orange County.
GlobeSt.com: What types of redevelopment projects are getting the most attention, and are there any geographic patterns within the OC market?
Giordani: Blend and extend is the name of the game. Investors are snapping up buildings and portfolios with short lease terms, tired facades, and deferred maintenance and adding sharp common area design, bumping rents that are slightly below market to incentive tenants, and providing accessible, yet institutional property management services.
Marshall: We’ve seen our clients chasing core plus and value add acquisitions in accessible submarkets with good amenities. At this point in the cycle and in a rising rate environment, equity and their lenders are happy to take lower yields for a quick two to three business plan. Lending on buildings that have mid-sized tenants remains attractive because Orange County has so many privately owned businesses with long track records and expected future demand for their services.
GlobeSt.com: How does appetite for redevelopment compare to new construction projects?
Giordani: Institutional equity has the benefit of a lower cost of capital and the downside of having to get money out the door, so they chase development projects with lower yields. The largest landowner here in Orange County can build office product extremely cheap compared to competitors since they’re not buying the land.
Marshall: For regional owners and merchant sponsors, redevelopment offers the most attractive risk-adjusted returns. They can typically underwrite a mid-teens IRR over a mid-term business plan, slap on cheap bridge debt from a pension fund, life company, or debt fund, and your downside is a rate and term refinance allowing you to clip a pretty good coupon if the economy turns or cap rates expand.
GlobeSt.com: How will interest rates affect borrowers looking to secure funds for these types of deals?
Giordani: Rates are undoubtedly rising in the short term. The fed funds target increased this week, and the Fed has provided guidance for at least two more increases this year. If inflation truly picks up, you’ll see the Fed and other large central banks tighten up.
Marshall: Borrowers should expect to purchase short-term interest rate caps, typically two years to reduce cost. As part of their business plan, they should reserve some capital for rate increases, or plan to sweep cash flow to plan for higher rates beyond the initial “fixed” rate portion of the loan.
GlobeSt.com: Why was an institutional non-bank lender the best choice for this project?
Giordani: For deals with cash flow, there are many life companies and pensions funds that have new buckets of capital to chase riskier business than in the past. These institutions are concerned about meeting pension liabilities down the road. We’ve found their money is cheaper, easier, and more flexible with covenants and ownership structures. This particular lender closed on an acquisition inside of 30 days and worked with us to streamline legal costs. We’ve closed transactions as high as 85% of total project cost, non-recourse. The most interesting thing is that banks are starting to offer non-recourse loans, but they can’t compete on leverage, speed, or long-term service. That said, there are many great debt funds that can write loans on heavier lift business plans with little or no cash flow.
GlobeSt.com: Overall, are there any trends in the lenders that are most popular for these deals?
Marshall: Bridge lenders are much closer to investors than bankers, and borrowers should view them as partners. With over 250 or so quality debt funds or life companies with a bridge bucket, work with advisors who understand that covenants, asset management, and execution matter just as much as the interest rate. The good news is, even though short-term rates are going up, credit spreads will continue to tighten as debt funds enter the middle stages of their life cycle.
— Read 5 Things Blackstone Says About Feeding the Annuity Issuers on ThinkAdvisor.