Carl Gaines Nov. 2, 2012, 4:30 p.m.
Doug Stern had a real estate dream. In his early 40s, after years in private equity and managing his family’s commercial real estate properties, he longed for a career change and a development project on his own. His mission became clear in Bayonne, N.J., where, he said, he fell in love with the former headquarters of the intimate apparel company Maidenform. Located two blocks from the Hudson-Bergen light rail 22nd Street station, the four-story, 94,000-square-foot brick complex—over 100 years old—was familiar to generations of Bayonne residents, many of whom had worked there until the company moved to Iselin, N.J. in 2007. Mr. Stern saw the potential for the historic, vacant property into a Brooklyn-style 99-unit residential building.
Although he could buy the building, he figured that he needed upward of $20 million in construction financing to redevelop it.
Prior the crisis, bankers would have been happy—or, at least, open—to helping Mr. Stern’s dream become a reality. After 2008, though, despite his plans, vision and real estate experience, in the banks’ eyes Mr. Stern was just another new developer.
In recent months, droves of would-be builders have been knocking at banks’ doors hoping to take advantage of the return of construction lending. But most lenders see a lack of demonstrable development experience as simply too risky. Mr. Stern faced many rejections, before finally finding a loan that will allow him to start construction by the end of 2012. Countless others’ ambitions run into more abrupt ends.
The last 18 months have gradually seen a return to construction financing in the tristate area and across the country. In the second quarter of 2012, commercial and multifamily mortgage origination volumes in the U.S. were up 25 percent from second quarter 2011 levels, and up 39 percent from the first quarter of 2012, according to the Mortgage Bankers Association’s Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. Mortgage rates under 4 percent continue to provide more than ample incentive for borrowers.
Particularly in the New York area, according to the MBA’s report, small- to-medium-sized banks reported “a noticeable pickup in overall loan demand.”
Several bankers confirmed this trend to The Mortgage Observer.
“A lot of people are trying to enter the multifamily business in New York, to jump on the bandwagon,” said Joseph Orefice, senior vice president and head of Commercial Real Estate Lending at New Jersey-based Investors Bank. “We see tons of new developers.” The number of requests from new developers that pile up on his desk have increased by roughly 100 percent, he estimated. This doesn’t mean that the bank is willing to take risks, though. “Everyone can ask,” Mr. Orefice said. “The percentage that actually closes is very small—maybe less than 1 percent.”
“About 40 percent of the people that contact me are new developers,” said Shannon Eidman, a senior vice president with Chicago-based Builders Bank. “We are very selective,” he added. “Of these I may do two or three deals a year.”
Other representatives of small and medium banks will not consider providing financing for new developers at all. For instance, Christopher Deutsch, vice president with Doral Bank, said he would not consider financing new developers even for smaller renovations.
After the financial crisis, lenders raised the bar with respect to their requirements for developers’ experience, track record, development team, net worth, contingent liabilities and the post-closing liquidity, sources said.
“While in ‘the old days’ of 2006 or 2007, it was possible for a brand-new developer to qualify for construction financing, today even obtaining 60 percent loan-to-cost financing for a first-time developer can be supremely challenging,” said Gregg Winter, president of Winter & Company, a commercial mortgage advisory firm which focuses on sourcing debt and equity for new developments, and founder and managing partner of W Financial Fund, a Manhattan-based direct, private bridge lender that specializes in quickly closing time-sensitive loan requests.
Doug Stern was fully aware that pursuing his Maidenform complex project on his own would have been almost impossible. In 2009, he reached out to his friend Leon Cohen. An architect and developer with over 30 years of experience and a principal in CSR Construction Corp., a New Jersey design and construction company, Mr. Cohen had met Mr. Stern when working on a renovation of Mr. Stern’s family’s buildings.
By this time, the Maidenform complex had dropped in price from $5.8 million to just $2.2 million.
Mr. Cohen immediately saw the property’s potential and agreed to partner with Mr. Stern. “He bought the building and as a part of my investment I produced the construction drawings and the budgets,” Mr. Cohen remembered.
Mr. Stern, Mr. Cohen said, had financial knowledge and a knack for dealing with banks, but he needed an experienced partner. “Banks today are so sensitive to the possibility of a failed project that they want to see previous development experience,” Mr. Cohen said. “It’s beside money—there are many people who have money.”
A guarantor or a partner are “mitigating conditions” that banks might consider in dealing with new developers. “In some instances we have found a mitigant in the ‘new developer dilemma,’ where someone is willing to join the new developer on guarantying the loan,” said Builders Bank’s Mr. Eidman, who offered as an example developer parents who act as guarantors for their children’s first developments. Obviously, having such a guarantor in the family is a huge help.
Others might look for a guarantor among people with whom they have done business. “If the additional individual is willing to back up the new developer with their guarantee, and that person has experience developing projects but may not necessarily want to take the lead on this particular deal, we could conceptually consider their strength,” said Mr. Eidman. “In the event something started to go sideways on the deal, the experienced person could step in and correct the issues, and would want to do so because they have a vested interest in the success of the project as a guarantor.”
Firms such as Winter & Company, Mr. Winter said, often arrange joint ventures between new and more experienced developers. This is a great way, he said, “to learn the business faster and to avoid the countless—and often very expensive—errors that new developers often make.”
Another factor that banks like Builders Bank might consider is a new developer’s previous experience in managing developments for others. “If you are a GC [general contractor] who has never built [on his own], this is a deal I would look at,” Mr. Eidman said. “This is an easy one.”
Investors Bank’s Mr. Orefice recently closed two deals in New Jersey. His tips to new developers are “to make sure that they have plenty of equity” and “to begin a relationship with the community of investors.”
In the struggle to obtain financing from banks, new developers often look for alternatives among private lenders, hedge funds and private equity firms. However, these alternatives often come with higher costs.
“We are currently financing new developers,” confirmed Steven Parrinello, a vice president with Hudson Realty Capital, a real estate fund manager. Currently, the firm has over $1.5 billion of assets under management; it provides loans in the $5 million to $50 million range. Since the formation of its two initial funds in 2002 it has closed over $3 billion in transactions.
“There is still a lack of capital for development in general,” Mr. Parrinello said. “In the middle market, we see even less capital, so we have been busy with development financing.” In New York, the hotel and multifamily markets are very attractive for smaller developers, he added, but obviously, for them, the costs are different.
“Hudson offers higher advance rates than traditional banks, while our cost of capital is slightly higher than banks,” Mr. Parrinello confirmed.
Coming from private equity, Mr. Stern was well aware of these variations in costs. “I like being the hard money lender, not the borrower,” he said. “I’m a very low-risk kind of guy.” With hard money, he realized, his cost of money would be severely higher.
After closing on the Maidenform complex in November 2009, it took almost three years and discussions with 11 other banks before Mr. Stern obtained a $12.3 million construction loan from M&T Bank. Construction is due to start soon, but for now the former factory sits empty. In one small room, serving as an office, renderings sit among faded 1960s Maidenform ads. It will have rental units from studios to three-bedrooms, live/work units for artists, a gym and community spaces. An outdoor space between the factory and a former warehouse will be turned into a common garden, and a brick industrial chimney transformed into a pizza oven for the tenants.
“New developers must have an edge in some respect,” theorized Mr. Winter. “This might be a great location acquired at a better-than-average basis, or a partner with very deep pockets and strong liquidity that is willing to co-guarantee the construction loan.”
“I think you have to know your limit,” Mr. Stern posited. As a new developer, he said, he had to be realistic about the fact that there was only so much he could negotiate. He also had to be willing to ask for help when needed.
“I didn’t know if I was very smart or very stupid,” he said of the risk associated with his first development project. “Now I hope that this will be just the first of many future developments.”