LOS ANGELES-While commercial real estate has regained its allure for investors chasing return premiums; as a whole, opportunistic investors are working with a different set of objectives than the institutional buyers.

Institutional buyers are happy to accept a 4% to 6% return on in-place, stabilized cash flow in exchange for relatively low risk. 

Alternately, opportunistic investors seeking higher yields and accepting additional risks, have focused on identifying value-add/asset repositioning strategies to reach their return goals.  Prevalent strategies include stabilizing troubled assets such as broken condominiums, office, retail and multifamily assets with vacancy, poor management history, significant rehab requirements, repositioning in the market, etc. 

These strategies usually require the investor to purchase the asset well below replacement costs, invest additional dollars, and then sell the stabilized asset at a lower exit cap rate (higher multiple).

Because the property is in transition and not yet stabilized, permanent financing is either not available at sufficient leverage or requires significant prepayment penalties. Commercial banks and the more opportunistic debt funds have broadened their bridge lending platforms over the past two years.

A bridge loan is a short-term financing facility with a typical term of two to three years, sometimes longer, with extension options.

There are a number of differences between commercial banks and debt funds as to how they structure and price their loans, their ability to close quickly, and their requirements for recourse.

Commercial banks are regulated and therefore are required to receive an MAI appraisal prior to funding, thereby slowing down their ability to react expeditiously in quick-close situations.

In determining loan amount, banks will usually require that the property have minimum breakeven debt coverage at closing; and, while loan to value is always a consideration, banks focus more closely on the loan to cost and typically  will not lend above 70% to 75% of total cost. Similar to a construction loan, banks will fund TI and LC costs.

Bank loans normally require full recourse to the sponsor; but, there may be some flexibility for very strong borrowers and for lower leverage transactions. As recourse lenders, banks underwrite the sponsor's financial condition carefully, sometimes even more so than the real estate. Pricing ranges from 2.0% to 3.5% over LIBOR and have a ½% - 1% origination fee and ½% - 1% exit fee, which is waived if the bank funds the permanent loan on the property.

Debt funds tend to be more entrepreneurial than banks.

Not governed by federal and state regulations, most debt funds will not require MAI appraisals. The funds have more discretion than banks and are flexible in structure, pricing and leverage points lending up to 90% of the projects costs.

Pricing is a function of asset quality, location, experience of the sponsor and business plan and ranges from 4% to 7% over LIBOR and typically has a 1% origination fee and a 1% exit fee.  Debt funds that have a conduit arm or do balance sheet lending will typically waive the exit fee if they fund the takeout. Loan proceeds are not all funded at closing; but, are drawn down by the sponsor as needed. 

Debt funds have the capability of funding below a breakeven DCR and structure an interest reserve to carry the loan prior to stabilization; however, loans below breakeven coverage are usually recourse to the sponsor. 

A key distinction between funds and banks is that funds focus more on underwriting the asset while banks tend to focus more on the sponsor's credit.

Gary M. Tenzer is principal and managing director of George Smith Partners. The views expressed in this column are the author's own.