Striking Equilibrium in Real Estate Finance
Today’s real estate finance market in New York City is different in almost every respect from both the bubble period of 2006 through 2007 and the doldrums of late-2008 to mid-2010.
Looking backward from 2006 and 2007, it was easy to gather data showing many years of extraordinarily low default percentages at every level of the debt capital stack and great profitability for equity investors. To make a supportable argument about why a loan or investment would go bad at that point, one had to be willing to bet against mountains of good data. And with most players in the capital industry at that point compensated primarily according to production, there wasn’t a whole lot of incentive to do so.
Looking backward from early 2010, there was virtually a total lack of up-to-date hard data, because so few deals of any type had closed since Lehman fell in late 2008. It was undeniable that values had fallen, but almost no hard data existed to prove to what level; and any suggestion of relying on pre-2008 data was dismissed as prebubble folly.
Today is an interesting melding of the two periods, carrying legacies of both. The parties who stand to gain the most if they succeed in buying near the bottom of the cycle (borrowers/developers) can point to tangible strengthening in fundamentals to date (especially in major markets). Yet those with more to lose than to gain (regulators and credit officers who don’t share in the upside) have retained very clear memories of a not-long-ago period when everything seemed to be going down the tubes.
While there is now enough commonality of vision between buyers and sellers of both properties and money to have spurred the return of significant transaction volume, we have entered a period quite different from any other in my experience or family knowledge base.
The very good news is that the deals are closing. However, many aspects of most closing processes are a tale of woe. The headaches involved in the processes have everyone from bank presidents and loan officers to mortgage brokers, borrower principals, lawyers, appraisers and correspondents aligned in their contempt for the pace of most deals.
For 2011, the issue is frustration rather than disappointment, and while without question it’s better to be tearing your hair out over a slow closing process than banging your head against the wall over a lack of them, a multitude of previously ignored or even unheard-of issues slows down virtually every deal.
This level of frustration with the process has moved beyond a tangible undercurrent and out into an open and frequent topic of conversation. There are several causes behind the problem—most important is the remaining overhang of fear from 2008 and 2009’s look into the abyss.
At times it feels as if the industry is fighting an internalized psychic battle over the changing notion of self-preservation. In 2009 and for much of 2010, it was clear to both producers and credit/risk officers that not doing deals was the safe path: the most likely way to look bad was to do a new deal that went the wrong direction.
By late 2010, a psychological shift had occurred among producers, who realized that the accumulation of too many successive quarters of nonproduction was beginning to look more like a stain than a badge. In recent months, this has led to a divide between the producers and those charged with maintaining their discipline that has never been greater.
By necessity and by design, battalions of regulators, credit officers, committees, closers, servicers and rating agencies continue to apply the great downward pressure mandated by the depths of 2009, and with good reason: they are the gatekeepers, and they are taking their jobs very seriously.
Unfortunately, however, when this role translates into mandated overzealous cautiousness, it can cause tremendous waste of both human capital and dollars.
On a recent loan that did eventually close with no change in deal terms, a team including six lawyers, two insurance consultants, two mortgage brokers, three insurance brokers, at least one city zoning official, three borrower principals, one loan officer, two correspondents and two closers spent three weeks negotiating, arguing and researching a question regarding a building that all involved agreed was a legal nonconforming use—only to conclude that the borrower’s in-place insurance policy was entirely satisfactory and fully covered the lender’s concern. During that period, several world events occurred that each had the potential to trigger the “material adverse change” language in the commitment letter and allow the deal to be terminated.
While it is important for producers and developers to maintain discipline and focus on fundamentals in determining whether to proceed on deals, it is also critical for rationality to exist within the logistics of the closing process. The pendulum has swung too far in each direction in recent years, and it is high time to seek an equilibrium point.
Scott A. Singer is a principal of the Singer & Bassuk Organization, LLC, and a member of REBNY’s Finance Committee. He writes regularly for The Commercial Observer about financing.