The Sea Change in Real Estate Psychology
Scott Singer, our regular contributor on real estate financing, on the end of a years-long rollercoaster.
Does anyone know a good analyst? After a three-year evolution in which the real estate transaction market went from manic to fearful to panic-stricken to catatonic to cautious to tentative, it has now arrived at fully operational.
For the first time in years, properties are trading in processes that could be called relatively normal: assets are offered for sale at prices that are within the realm of possibility, negotiations ensue and contracts get executed. Soft contract deposits are back, even in New York City, a great indication that motivated sellers have become an active part of the scene.
Capital has been available throughout the entire slowdown, even for the long, dark period when the deals were not. One concern that has existed (in my office at least) over the past 24 months was whether the supply of available capital would dry up before the active trading returned. Well, quite clearly it has not-and the past several weeks have seen the long-awaited mixing of a flood of eager consumers of capital (borrowers/developers) with strong collateral and a weary group of capital providers ready to trade busy-ness for productivity.
The most frequent question I have been asked by both developers and capital providers over the past few weeks is, why is there such a dramatic uptick in activity right now?
I believe there has been a sea change in the psychology of the market within the past month that can best be described as the onset of a pervasive expectation that transactions will get done; this replaces the long-standing fatalistic assumption that for one reason or another deals would stall. Who can know how it finally started rolling, but word has been spreading of more-than-a-trickle of tangible results, like contracts being signed and loans getting closed at very low long-term rates, or even handshakes being reached over price, etc., and no one wants to miss out on the action.
Interestingly, in many transactions now, buyers and sellers seem equally motivated-whether by divergent views about the future, portfolio-specific concerns, cash requirements or investment needs. The result, in Wall Street-speak, is that a market can be made for most properties.
This is welcome news for the capital markets. Over the past 24 months, there has consistently been a great oversupply of capital relative to the number of good deals seeking financing. Recently, that equation has reached something close to equilibrium, with deals arriving from sources ranging from opportunistic acquirers to long-term holders motivated by low borrowing rates, and many lenders are seeing more good deals come across their desks than they have the personnel and resources to handle.
Even construction financing is available and the best development projects are finding aggressive competition from both senior and subordinate capital sources.
One effect of the rapid expansion of real deals is a great range in pricing among both senior and junior financing providers. There have not yet been enough closed and reported transactions for the firm establishment of “market pricing,” and the delta in yield between initial and accepted offers is the highest at any time in the past 15 to 20 years. This is an environment in which a broker adds great value as a market-maker, whereas sole-sourcing a transaction to an existing source can result in an owner’s leaving substantial value on the table.
One recent first-mortgage loan process saw initial bids at spreads greater than 200 over Treasuries, followed by a negotiation process that resulted in a term sheet being executed 10 days later at 150. On a riskier mezz/preferred equity offering, initial bids started at 19 percent, and the final term sheet was soon executed at 12 percent.
A great dichotomy exists between the strong aggressiveness shown by lenders and investors when considering excellent transactions vs. the weak appetite for marginal deals. The definition of an excellent transaction today can vary significantly, although there are some bedrock concepts that must exist: 1) an experienced borrower/developer undertaking a project similar to what he or she has completed before; 2) an established neighborhood with truly relevant comps; and 3) underwriting based on today’s fundamentals (and not dissimilar from 2010 fundamentals) rather than on expectations of market (or marked) improvement going forward.
It is certainly difficult to pinpoint the ideal time to jump into the market, but a wide variety of experienced and savvy developers, operators and investors have clearly found a set of circumstances that have spurred them to action. Those who dealt with negative issues appropriately in recent years (or avoided them altogether) and who are now sticking with projects that are well within their expertise are reasonably likely to find attractive capital lining up to participate with them.
Scott A. Singer is principal of the Singer & Bassuk Organization LLC, and a member of REBNY’s Finance Committee.