With the demise of some of the biggest Wall St lenders, as well as the severe contractions of some of the commercial finance companies, there is a huge gap of capacity in the lending market now that real estate values and cash flows are once again on the upswing. There is not going to be the flood of distressed paper and properties that we all had anticipated, and now that banks are in much better balance sheet condition, they are in a better position to find ways to workout problems with their better customers. Most of the really bad loans either have been or are in the process of being dealt with. While there are still hundreds of billions of loan maturities yet to come, it appears from situations I have been involved with as an advisor, that further extensions and modifications are continuing. At some point all of these loans do need to be refinanced. It is also clear that a lot of loans will not qualify for CMBS executions over the next few years with the better and tighter underwriting standards.
There are inevitably people who recognize a need and move to fill it. A number of experienced teams are now attempting to raise capital; to form new lending platforms. Some are intending to stay focused on just recreating commercial lending operations focused on doing traditional $5 to $50 million real estate commercial finance lending. Others are intending to build much bigger platforms over time by starting with straight commercial lending then expanding to include mezzanine, and eventually CMBS platforms.
What is interesting is the appearance of some offshore private groups who also see the opportunity and are bringing the capital in search of a team. These are private family or company operations that have the capital to support a modest operation here, say $100 million equity, and then intend to raise additional capital in the US as the operation ramps up. Some are intending to create substantial US platforms.
With warehouse lending staring to return, although in a much more responsible way with lower leverage and more careful underwriting, the leverage will still be sufficient to materially grow the platforms. In addition, there is now a vibrant A piece market so that these new finance companies will have the option of selling off the top 60%-70% of their originations to further grow their origination capacity.
Based on what I have seen and heard about lately, I believe that a year from now there will be more lending capacity than many had expected. As the economy continues to repair, and as cash flows continue to return, there will be ample opportunity for these new lenders to find plenty of good product and to make reasonable returns of 15%- 20% levered. If you consider that by making sound, but slightly more aggressive loans than the banks or CMBS will do, you have a relatively moderate risk portfolio of first mortgages on assets which should continue to increase in value over the next 4-5 years, then you have to ask, is the equity investor return worth the higher risk. Given what we have just lived through it is the right issue to look at. If one realizes that many equity funds got killed over the past three years by taking excessive equity risks, then it is not unreasonable to suggest that making a solid 16%-18% return on lending in a secure position is not bad at all. The key to all of this is to remember what good underwriting means and not to let the market force you into making excessive loans with weak covenants. When that point happens, as it inevitably will, it is time to sell the platform or to simply run off the book.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
