The supply of real estate properties will continue to grow, more assets are changing hands, increased competition for those assets has begun to drive up values and interest rates have started to rise.
The bottom line for situational lenders, as well as owners and developers, is that the next few years will continue to provide a window of opportunity.
This commercial real estate market investment forecast for the remainder of the year and 2014 is being offered by the principals and co-founders of Case Real Estate Capital LLC, a private direct lender whose middle-market situational lending platform targets transitional assets. Case also has the ability to purchase sub and non-performing loans direct from lenders.
In the following commentary, managing principal Sanford Herrick and principals Steve Milona and Scott Hartstein provide a forecast for the highly profitable opportunities ahead as traditional and institutional lenders continue to shed their sub- and non-performing loan portfolios.
Q: Has the pace and heightened volume of sub-performing properties coming to market started to wane?
A: “The number of available properties is actually on the rise and will continue to increase well into the coming year and beyond. Interestingly, this trend has not dropped prices because the competition for these properties and this business is mounting.
“This should continue for at least another two or three years, since so much product — a result of previous price declines — has been on the sidelines.
“Banks or institutional lenders will have more assets that will increase inventory of REO assets, which should increase internal pressure to shed them from their balance sheets as soon as possible,” said Herrick, who has invested in more than $4 billion of commercial properties during the course of his 30-year career.
Q: What is a “typical” profile for today’s value-add property?
A: “A good majority of these properties are transitional situations in middle markets. Financing needs to run the full gamut, from short timeframes to complex situations, like storied assets and restructurings.
“We’re also seeing turnaround scenarios involving litigation, contaminated sites, non-cash-flowing properties, weak credit history, bankruptcies, foreclosure and property repositioning, as well as development or redevelopment. All of these require the swift, efficient infusion of capital,” said Milona, who has more than 10 years experience making complex commercial real estate loans.
Q: While many traditional lenders and investors continue to balk in a marketplace still filled with uncertainties, are financial markets and lending institutions paying any attention to these opportunities?
A: “In general, many are more comfortable and aggressive with putting money into first-class real estate in top-tier markets – not the middle markets. Despite this divide, the number of real estate assets sold in the past year has increased across the board and we believe that trend will continue.
“This, in turn, has driven up the prices of these assets in general, a trend that should continue as more investors who can obtain financing return to the market, especially if interest rates remain at their current rate. Nobody really knows when a significant rate increase might actually happen, so most potential buyers should assume a significant increase is really a matter of when — not if.
“Investors should be focusing on getting the best financing deals they can, as quickly as they can,” said Hartstein, who has more than 18 years of situational-lending experience.
Q: Which geographic markets offer some of the best value-add opportunities?
A: “We believe there is a high concentration of opportunities throughout the Northeast and Mid-Atlantic regions for funding and acquiring loans between $5 million and $25 million secured by commercial real estate. For a situational lender like Case, we want to be the vehicle that gets borrowers into a long-term hold position.
“Each loan is evaluated on its own merits, based on the borrower’s unique situation and local market conditions.
“We are nimble enough to pierce through a property-specific issue in order to minimize risk and achieve value – a win/win for the borrower, us and the neighborhood in which the now stabilized property is located,” said Herrick.
Q: How has situational financing changed the commercial real estate landscape?
A: “Speed and decisiveness are inherent to today’s commercial real estate investments and have become synonymous with situational lending.
“Experienced owners and developers are financing their transitional assets with these types of loans, which are structured to render the asset conventionally financeable within a defined period of time. Terms range from as short as 8 to 12 months, to 18 or 24 months or longer.
“Borrowers cite the streamlined underwriting and due diligence process as their top reason for partnering with a situational lending platform,” said Milona.
Q: How can risk be minimized for transitional assets?
A: “Every deal needs to stand on its own. More importantly, so does the business plan. Even if the original strategy is not realized, the borrower must account for alternatives to ‘right the ship’ through an alternative means like adaptive reuse or some level of renovation or rehab to increase cash flows and values.
“Over the course of the next few years, we do not expect there to be a shortage of commercial property buyers. However, we do expect there to be an enduring shortage of money, particularly within the middle markets,” said Hartstein.