Customized CRE Financing Options for Challenging Times
July 1, 2022 4 min read
With disruption and change taking place across the commercial real estate lending environment, sponsors find that their needs are evolving with the times. The lenders who achieve success through the uncertainty will be the companies that can shift and evolve, remaining attuned to the changing needs of the different sectors they serve.
Whether a sponsor is an agency or a balance sheet borrower, current volatility demands that lenders devise customized solutions, ditching a one-size-fits-all mentality.
"The key is being able to offer a full suite of products to our clients," said Steve Klufas, senior vice president of commercial real estate at Capital One. "Whether they're a regional client or an institutional client, being able to offer construction, bridge or permanent financing is key, because you can grow those relationships organically and support them at any stage."
Rossana Bouchaya, senior vice president of agency finance for Capital One, noted the stark changes in recent borrower behavior that every lender needs to recognize and address.
"This past year, we saw clients that were traditionally agency borrowers shift to embrace other capital sources because of the current market volatility and cap rate compression," Bouchaya said. "At Capital One, we've encouraged borrowers to be flexible about other lending sources. That includes products we can offer internally and those where we find an external capital source for them. We have a number of debt fund relationships, and we've been able to facilitate excellent lending options for our clients that way."
To that end, Capital One's variety of balance sheet lending solutions includes mortgage-secured, subscription-secured, unsecured or real estate investment trust-style capital, and note secured or repurchase agreement, aka repo, capital. Within agency lending, the bank also handles short- and long-term mortgages and sells them to the agencies.
"The difference is that institutional sponsors that invest through commingled funds can use subscription financing for additional liquidity upfront," said John Blackwelder, senior vice president of institutional specialties at Capital One. "Then, they'll typically replace that with either secured or unsecured debt, whereas in the agency business, most borrowers tend to finance each asset separately, so timing is more critical."
In the midst of this shifting landscape, one clear favorite has been the bridge loan, which is seeing its popularity rise due to factors including cap rate compression.
"Underwriting for agency loans hasn't changed during this market volatility, and with cap rate compression, we often can't get to the leverage that many clients need to win those acquisitions," Bouchaya said. "This is especially true for borrowers who are buying with a value-add business plan. In these cases, they are paying renovation costs on top of the down payment. So, they need higher leverage financing in order to secure the bid and execute their business plan, and bridge financing has really stepped in to fill that need."
Klufas noted that many investors are now seeking out more value-add returns, repositioning Class B or B- products and gearing themselves toward higher returns than one might earn buying a Class A product at a compressed cap rate.
"In our bridge-to-agency program, we worked with a longstanding agency client on a multifamily deal for a 1970s-built property outside of Sacramento," said Klufas, who manages the company's bridge-to-agency program. "They've never used the balance sheet. We offered them a solution, but the asset wasn't ready for the agencies. We gave them a good structured bridge loan that is expected to get them to an agency takeout in the next three years."
"Bridge has also become a more popular option for acquisitions where investors want to put long-term U.S. Department of Housing and Urban Development debt on a property," added Bouchaya. "HUD has changed its rules to allow for refinancing on newly constructed properties. However, a HUD loan can take six to nine months to close, which doesn't work for standard acquisition timelines. With our bridge-to-HUD product, sponsors can close on the acquisition with bridge financing and then refinance into the HUD takeout. That's a new product that's been really successful for clients who want a typical long-term HUD loan but need to solve for fast acquisition timelines."
Bouchaya said that the first bridge-to-HUD loan her team originated was 83 percent loan-to-cost, which is a high leverage loan that is more in line with HUD's ability to go up to 85 percent loan-to-cost.
"We have structured this product so that eligible properties can be refinanced at HUD's full 85 percent HUD takeout potential, so it has to have a high leverage bridge to go into that," Bouchaya said. "This product has been successful, with borrowers executing their business plans before we do the HUD takeout. We're really proud of that one."
Capital One's ability to adapt to current conditions and steer its commercial real estate lending products accordingly ensures its clients are constantly able to respond to market volatility.
"A lot of my clients are acquisitions focused. They need higher leverage to make their returns work, and to be competitive and win those acquisitions," Bouchaya said. "We need to be able to do more than just one thing. We must be able to lean on our full internal products suite and compare to external products to find what works best for clients. It keeps our clients sticking with us, and it grows the relationship. It's a win-win."
And this is the ultimate benefit for Capital One—a tightening of relationships, showing clients that the bank will find solutions to their lending needs, wherever those solutions may emerge from.
This article was originally published on Commercial Observer.