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CASH OUT REFINANCE

ECONOMIC DATA / NEWS Wednesday 9/21/2009

Liquidity Exists

First, let it be known that liquidity does exist. The capital markets are evolving rapidly, with players entering and exiting weekly. The market is highly inefficient, and locating capital demands a lot of ground work. Those with real capacity and discretion are few and far between; most are only pretending to be active to protect their brand. But the truth is revealed when the best opportunities are presented – and excuses are eliminated. In this way, the real players are starting to surface. A select group of lenders and institutional equity investors do indeed have capital; what’s more, they want to deploy it.

However, capital has almost universally been out of the game for 12-24 months, and it is very cautious about re-entry; the first deal in 12-18 months is going to have to be nearly perfect. Capital has to be compelled in order to overcome endemic stand-still inertia.

Economic Underwriting

It goes without saying that the underwriting treatment for both debt and equity is radically more conservative today. We’ve all seen deals killed by conservative assumptions. For example, we recently note:

Rents marked down to a very conservative estimate of “market” rent;

Conservative underwriting adjustments for total cost of occupancy, considering RUBS, NNN expenses, capital costs, etc.;

Vacancy underwritten at the higher of 10% or actual-market (rather than the traditional 5%), with careful attention to direct versus sublet space, economic versus physical occupancy, and concessions;

Conservative allowances for re-tenanting in terms of cost and absorption rate; and

Draconian exit cap-rate assumptions.

Compelling Opportunities

In additional to these types of baseline economic hurdles, and inertia holding the investor at a stand-still, the successful deal will be “compelling”. This includes:

Best-in-class sponsorship with a long track record of success in the specific subject market and product type;

Making money on the “buy”, where the dollar-per-pound project costs represent a significant discount to replacement cost; and

Safe foundation of cash-flow, where a conservative estimate of stabilized NOI over costs is higher than a reasonable exit cap-rate assumption.

Risk-Mitigation

In addition to being compelled, capital also demands supplementary risk-mitigation measures to satisfy extreme risk-aversion, such as:

Conservative business plans, including the capacity, investment horizon and debt term to safely “carry” the project in a down-side scenario for 5 years;

Underwriting sponsor liquidity to solve problems, exposure to maturities in their existing portfolio, and legacy portfolio risks;

Carefully considering the availability of capital to support the exit, and investing only where they can confidently predict a take-out financing or buyer liquidity;

Selecting stable or recovering markets, or building in a significant cushion for further deterioration.

Caution Over Speed

What’s more, capital won’t be rushed. Decisions are made by committee. In the good-old-days, a well connected intermediary could make “the call” for a quick thumbs-up / thumbs-down from the key decision maker, with 80-90% accuracy. Today, a diverse panel of stake-holders is consulted. Diligence is thorough. The fact set must be complete. All eventualities must be considered. Risks must be defined and mitigated. The deal should expect to wait for the money.

This reality is frustrating, because the “perfect deal”, by definition, is “distressed” and therefore trading on a short fuse. So what’s a deal-maker to do? Prepare.

Thanks for your business and have a good week.

P.S. We are still lending; now more than ever you need a commercial loan broker to get your deal done right.

Wes Lewison,

Investment Property Specialist (949) 218-4007 Direct