Non-Recourse Construction Loans for Commercial Real Estate & Multifamily
As Advisors, our role is to provide options to our clients that they may or may not know about or have considered in the past.
The Issue
We have many developer clients chasing construction loans in an unending circle of rejections, deferrals, un-papered verbal quotes, or quotes at far lower leverage than expected.
I have personally been told, “I am sending this deal to you because my long standing relationships have lost their minds.” Meaning that there are some developments that should be highly profitable and make great sense, but their lenders are not interested. For me, its not the best way to take in new business, but I will take it!
We solve this problem, either with an ‘apples to apples’ loan which is a directly competitive set of options maybe with more dollars or longer term OR with a non-recourse construction loan. It comes at a higher price (rate), but in this case when you pay more, you get something for it. The leverage is generally very good too. We call this ‘throwing an orange into the mix’.
SOME HISTORY
In 2009, when the lending world, as we knew it came to an end, the first casualty was the non-recourse construction loan. It made sense. As lenders were directed away from risk, the first thing to go should be the riskiest of all loans. Wachovia had a great program… as did a few of the others, but Wachovia was the best, in my experience, which is generally deals from $10,000,000 to $50,000,000. They were looked at as being trail blazers in risk.
What makes this loan more risky from a lenders standpoint?
Along with all the normal risks of making a loan, you have the risk of the construction world changing, contractors going out of business, litigation, and a risk that the market changes during the construction term which results in an obsolete building at CofO.
Has this ever happened? Yes, in our backyard. Many buildings that were built as condo’s, lost their buyers during construction, and became far over improved apartment buildings. Tenants had the ability to rent in a high-rise with the best finishes and amenities for less than most apartment rents during this time. Lenders got stuck with relatively low rents for high priced product… an obsolete building, at least for the short term. As a side, I remember hearing the commentators say that Miami had a 12-year inventory of condo’s in 2009, and that there would be no need for new construction until the mid 2020’s. Boy were they wrong…
What makes this loan more risky from a developers standpoint?
From a developers point of view, there is a hidden benefit. Many developers have gotten into trouble through no fault of their own. Lenders have been shut down or gone out of business mid construction loan, many times. The developer has draw requests unfulfilled, then they can’t pay contractors, and has nobody to go to for help. Nobody. Any years later, you are still in litigation, and judgments with your name on them are being traded by everybody who wants to reach into your wallet. With non-recourse, this will not happen.
TODAY
Anyway, the non-recourse construction loan has been elusive. It has never been overly popular from a lenders point of view. Now, in a world where banks are regulated to very high degree, it’s not in the cards. So, the gap is being filled by private equity funds. Ha! Leave it to those greedy SOB’s on Wall Street to fill a void in the market that has a huge demand, and no supply. Now, there are a few suppliers, and the number may be slowly increasing.
In late 2016, I tied up my first fully non-recourse construction loan in years. Now, we have 2 moving toward closing, and a third that we are getting close on. By the time that I upload this, the first of these loans should be closed (see our Transaction section).
The fact is, typical construction lenders are not fighting over the business right now. Many are still waiting for some older loans to pay off, and others have ‘concentration issues’. Yes another reason is that lenders are saving their construction dollars for their Tier I existing clientele only. It is also a fact that we are winning this business based on the fact that it may end up being the clients only choice at certain leverage levels.
WHAT CAN YOU EXPECT
Here is what you can count on for a non-recourse construction loan in the $10,000,000 to $30,000,000 range:
70%-75% LTC
3+1+1 (years)
Libor Floater with spread ranging from 6.50% to 9.50%
Added Advantages – These lenders are not banks. They are not regulated like banks. Their underwriting standards have more flexibility, and a common sense aspect that is refreshing. Not to say that all banks are rigid, but lets say that there is a wide range of rigidity from bank to bank.
Yes, it is more expensive.
Yes, from a developer’s point of view, it is generally better to not guarantee a loan.
And yes, this money is readily available for developers, who understand that risk and return have an inverse relationship.
As mentioned, we are Advisors. Our role is to provide options to our clients and put them into decision making mode. We advise our clients to stack up recourse and non-recourse offers against each other. Based on leverage, non-recourse will likely win a fair share. But it is an option which most have not truly considered before. Providing options is what we do.
The Time’s are a Changing – Opportunities
Bob Dylan… “The Times are A-Changin’”. I am not pretentious enough to say that I appreciate him as much as others. Though it was impressive that he chose to skip the Nobel Prize due to having “other plans”.
He was/is right though. It amazes me how long it can take things to change, but when they do, it happens over night.
Case and point, since the election, rates are up over 50 bps on most commercial loans. There was no slow progression toward this, it happened over 4 days. If you were in the unfortunate position of having an active loan, not rate locked, you paid a price. The prospect of lower corporate taxes is very appealing to the stock market. This leaves more capital for companies to invest in growth of all sorts. Hence, a mass sell-off of treasuries to re-invest in stocks, and an upward bump to bond yields.
Borrowers become comfortable with the status quo. “I don’t believe that rates will change,” and “The government can’t afford to raise rates”. In this case, it wasn’t the government that did anything directly. A few weeks later, the Federal Reserve raised the short-term rate by 25 bps. This impacts floaters, credit card debt, and corporate lines of credit more than anything else. Not mortgage rates directly.
For real estate investors, yes, higher interest rates usually result in higher capitalization rates. So, you immediately assume that values should drop. HOWEVER, lower corporate and personal tax rates should positively impact rental demand and the amount of space that tenants chose to occupy, which should drive NOI up. There will be more money available for real estate needs. Also, having more money available to invest in real estate, certainly wont hurt.
OPPORTUNITIES – WITH UPWARD RATES
Allow me to set the table first. The lending market has become completely inefficient.
On the bank side, there is a lot of experimenting going on right now. We have terms for the same loan from different lenders that vary by over 100 bps for nearly identical terms.
The CMBS world claims to be back in action, yet their reliance on the 5-year and 10-year swap or treasury, or whichever is higher, is making them less competitive with every basis point increase. They have priced in the new risk retention, maybe too high, so spreads are high, dollars are low, and they cant seem to really differentiate themselves in any positive way. That will change, I can promise that.
Life Companies… same as above. Of course if you have a 30% LTV loan request, you will get a lot of attention and some outstanding terms with flexibility. I haven’t met that borrower yet though. If you are that person, please call me!
Agency spreads have not adjusted with the increase in treasuries. So, their rates aren’t so good today.
Table set. Here is what we see:
Opportunity #1 – if you have CMBS, Life Co debt, FNMA, or Freddie debt, your prepayment penalty has just dropped materially. It is time to re-run the numbers, and weigh the costs and benefits of waiting to refi. Yes, you will pay a larger prepayment penalty now, but you may end up with a lower long term rate.
Opportunity #2 – Compare the different lending sources against each-other. We are seeing more banks doing non-recourse loans, at the right leverage level, with almost no prepayment penalties. Compare this option to a securitized loan, which may be longer term, but may also be locking you out against opportunities that may come to sell or refi.
Opportunity #3 – We are seeing property sales fall apart due to the change in the cost of debt. Hurdle rates of return are not being met with the higher interest rates, so buyers are trying to re-negotiate.
We see sellers acting somewhat “appalled” by this, noting that they are playing both sides, as they try to re-negotiate terms on where their 1031 investment is going toward.
That property that you were out-bid on, may be coming back to market. We are now working on two requests (in the past week) that our clients were out-bid on, and now seem to have new life.
ADVICE
If you are working toward a closing right now… my advice is to rate lock ASAP. If you have not rate locked, we should show you some other options before you sign the dotted line. You will likely be pleasantly surprised.
If you have a CMBS, FNMA or Freddie loan with less than 2 years of term left, strongly consider refinancing now, paying the penalty, and locking in a solid long term rate while rates are still low.
If you are on a LIBOR floater, look to refi to a fixed rate, or purchase a cap, or do a rate swap.
If you are currently shopping debt or looking to purchase a property, patience will not be a virtue in the short run, it will be a detriment.
Be open minded. Your debt strategy will potentially set you apart from the pack of buyers right now. If you like multifamily, run the numbers with bank debt at lower leverage (to keep in as non-recourse). Factor in that there is minimal to no prepayment penalty. While every buyer is adding 100 bps in debt to their IRR formula, you may be able to leave it the same.
So, there you have it. While the “Times Are A-Changin” , the guarantee is that they will change again, and this blog will require updating. So, the song will far outlive where things are in finance today.
Non-Recourse Bridge Loans for Commercial Real Estate
In Caddy Shack, Ted Knight has one last shot in order to beat the Chevy Chase/Rodney Dangerfield/Danny Noonan team and win a huge bet on the tournament. For this, he needs to pull out his secret weapon… the Billy Baroo putter! He hugs and kisses this putter. Clearly, this putter has brought him much success.
For the team at Banyan Commercial Capital, the non-recourse bridge loan is our Billy Baroo. We feel a personal connection to the product, and have a chemistry with it, that inspires the comparison to this scene in Caddy Shack.
We have worked through some of the most dramatic market swings in the southeast in the past decade. This has resulted in opportunities to purchase properties, remedy issues that resulted from a lack of capital invested by previous owners, and upgrade the income. We have closed loans where the properties were operating at market, yet there was ‘outside of the box’ thinking that created the buying opportunity to enhance the income, lower expenses, and increase value.
Generally with a non-recourse bridge, there is a need for funds other than just a portion of the purchase price. This is why we base the loan amount on Loan to Cost rather than Loan to Value. We have structured capital improvements, tenant improvements and leasing commissions, operating reserves, interest reserves, and earn-outs for funds beyond the regular good news events. This is the typical bridge scenario.
These loans are riskier.
- Cash flows can be interrupted
- there can be changes in the market during the rehab process
- contractor issues
- new competition
- cost overruns
We must convince a lender that they are betting on the right sponsor, right property, and right business plan, and market conditions that will cooperate. This is what we do, and we do it better than anyone else.
There is a new scenario for bridge loans today. Permanent markets, are not aligned with traditional borrower needs. CMBS pricing and execution is not what it was last year, life companies are more selective, etc. We are now working on bridge loans for stabilized properties. Often, clients are willing to purchase a property with a bridge and wait for the permanent markets to come back in line.
For multifamily, we have specialized in what we term “Rehab Lite”, meaning that the rehab budget is less than $5,000 per unit, and that the property will not have to be vacated during rehab. Vacant units are done first, followed by lease roll. We have leveraged these up to 85% of total cost, and have also structured earn-outs for post renovation. We do this because, in the worst case scenario, if permanent loan markets are not efficient, the sponsor can cash out while leaving the existing loan in place until the permanent market returns. Our mutual hope is that these funds are not accessed, rather the loan is refinanced with a long term fixed rate loan, with cash out.
Retail and office properties are different. Most of our bridge loans are directly resulting from a purchase opportunity in which the seller was not willing or potentially able to fund Tenant Improvements or Leasing Commissions, let alone capital improvements. We have seen this often when the seller was some sort of syndicated equity, and capital calls were not successful.
Hotels are even more interesting. Renewals of franchise agreements are generally tied to Property Improvement Plans. When the sponsor does not have the funds necessary to comply, we step in. We have become increasingly creative with advising clients on how to leave as many rooms online as possible, by renovating individual floors, one at a time, or sections of halls, using temporary doors and blockades, so the other guests are unaware of work. We work on the business plan with the sponsor to get the desired product. And yes, non-recourse is available.
Our value add lies in the fact that the non-recourse bridge lenders are generally not household names. These are people that we know well, and programs that we know well. We guarantee that you will be impressed with the result.
Opportunities from Inefficiency
“I have been working with my bank for decades… they know me there”. We hear this several times everyday. My response back is “Are they treating you, a long time loyal customer, as well as I am getting other lenders to treat perfect strangers? Let’s have a look.”
Very often, years of loyalty are taken for granted, and the client is looked at as a sure thing, or that the effort of finding a new lender is just too much. Last week, we put this to the test with a new client, who was very open-minded. He gave me permission to write about this here.
We made a bet, he would get his bank to quote the loan, and we would get one single quote. We would exchange the term sheets over lunch, with the loser picking up the tab. We got the deal on Tuesday afternoon and met for lunch on Thursday (note his bank had a big head-start).
Now it is Tuesday morning of the following week, and the loan is in process with our lender. And lunch was delicious!
But that is not the lesson here. The quotes were not even close. We won on leverage, rate, term, amortization, interest only, prepayment penalty, and personal guarantee.
When the client called his lender to tell him what our term sheet said (during dessert), the lender said that it sounds like a life company deal, and that they don’t compete against life companies. When he was told that the loan was from a local bank, and which one it was, he said “we don’t compete against them either.”
So, you have a local lender that doesn’t compete against other local lenders that lend on the same property type, size, location, and borrower profile… I would be looking for new employment if I were him (I hope that he is not reading this… if so, nothing personal!). What is their niche? How do they survive?
I called this lender after (with client permission), to find what their sweet spot is. The answer, low leverage, high quality, short amortization, with clients that don’t need the money… I told him “I met that guy once, but he doesn’t live in Florida anymore.” (he and his unicorn are doing deals back in Fantasy land). The fact is, their primary focus is now SBA loans, which they never mentioned to their long time loyal borrower. Investment real estate is no longer their sweet spot.
We will close this loan in about 7 weeks. We will have a new client, who has a new bank relationship with new opportunities and lots of potential.
The lesson learned here, is that there is a wide range of possibilities with banks. Commercial mortgage rates can differ by over 1.25% from lender to lender. We have seen prepayment penalties from 0% for some to 5,4,3,2,1 structures to even yield maintenance. Personal guarantee structures that are also all over the place, as well as differing amortization schedules, extension options, assumability constraints.
This is an inefficient market: Lenders in the same area, looking at the same product, often have results that have nothing in common.
This is our opportunity to shine for our clients, and frankly is why Banyan Commercial Capital is in business. We spend countless hours on the phone and in lenders offices everyday. These personal relationships enable superior results. The ability to ‘call in a favor’ based on volume directly and positively impacts our clients. For us, this inefficient market has allowed us to dazzle clients with terms that they did not know were possible. Banyan will navigate the market and provide the client with options that best allow our clients to optimize their investment.
The Return of the Local Bank
Sure, they have always been around. Some are called Community Banks, other Savings Banks or Commercial Banks. But they are all effectively the same. They take your deposits, leverage them, and lend the money back out at a profit in the form of commercial mortgages.
How competitive have they been in commercial real estate lending? Earlier in this recovery, bankers told me, 
“For a commercial mortgage, we can’t compete against Life Insurance Companies or CMBS” or “we can’t offer long term fixed rate product at any leverage level.” I can’t tell you exactly what day it all changed, but it was in April or May this year. Now, we are off to the races.
Generally in commercial mortgages / commercial borrower, there is a perception that you have to give up something that you want in order to get something that you would want more. For example, you want a low long term fixed rate commercial mortgage, which means that you must give up any type of pre-payment flexibility. This meant that if rate and dollars were your priority, you would go to FNMA, Freddie, Commercial Mortgage Backed Securities (CMBS), or Life Insurance Companies for your loans. If the ability to prepay your loan without a ridiculous penalty is more important, you would stick with a local bank.
These two worlds have now collided. Banks have stepped up, and are now offering 7 and 10-year loans, with step-down prepayment penalties, non-recourse, at leverage levels approaching CMBS! Not just one bank… several.
In 2011, I had lunch with a local bank executive who explained that non-recourse loans would not be possible due to the regulators, and the increasing scrutiny on each bank that came with the crash of the real estate and capital markets.
This same person is now a non-recourse lender for stabilized product only, and could see a potential pathway to limited recourse or recourse burn-downs on structured bridge product. Another lender, quoting an office building for me this week, asked if a partial guarantee would ‘kill the deal’. When I said yes, the response was ‘ok, I should be able to get this done’. Wow! I can get a 10 year fixed rate, non-recourse loan on an office building, with a step-down prepay… I don’t think that I was able to get that done even in the best of times of the previous cycle.
So, it appears that banks are back and better than ever. The competition to land a good commercial mortgage from good borrowers has necessitated major shifts in terms, and our clients are fully enjoying the benefits. Still, the other commercial mortgage lending sources have their place and can offer certain advantages. However, the gap has closed, and I believe that CMBS, Life Companies, and the Agencies have been surprised by who they are competing against today, and how hard they have to compete today.