“The secret to business is to know something that nobody else knows.”—Aristotle Onassis
Almost everybody in the lender universe loans to the four main food groups: office, multifamily, retail and industrial. Approximately one-third of lenders will also advance capital on hotels—with the dissenters claiming it is too much of a business loan.
But ask lenders about a marina, a mobile home park or—if that’s not obscure enough—a church or a prison, and you will get a very quick “No thank you.”
It has always baffled me why lenders find it difficult to get comfortable with the dynamics of product types that aren’t that hard to understand. In most cases you have leases, predictable expenses, and a consistent operating history. My hypothesis is that it is simply the fear of the unknown. Institutional lenders loathe to go to their credit committees on something outside the box for fear that they will be criticized for taking perceived additional risk.
Even small funds hold the same fear that their investors will question why they are making a marina loan when these investors thought that the funds were investing in apartment buildings, shopping centers and office buildings.
This circular thinking leads to the reality that yields are substantially higher on these alternate product types than the main food groups as a result. The lenders that do lend on them have little competition and thus can ask (and get) very high coupons.
One thing that might be in the back of the minds of a few lenders that are reluctant to lend on these property types is the spectacular failures of some of the specialty lenders of years past. Textron Financial bought off on the concept on higher yields and only did unusual product types. This led to a vast portfolio of golf courses, ski resorts and marinas in the 1990s, which crashed from their highs during the subsequent recession. Resort properties are the farthest to fall during any downturn and Textron’s perceived diversification was misguided; as they all fell together. Other lenders like Fremont and Daimler Chrysler Credit are names in the past that also succumbed to specialty lending (though not exclusively) that didn’t end well.
But with all lenders desperately taking skinnier and skinnier yields on all of the same deals, it might be time to selectively get themselves up the learning curve on some of these deals. Let’s take them one at a time:
Self-Storage. This one almost shouldn’t be included because self-storage, from an equity perspective, is red-hot thanks primarily to REITs like Public Storage, Sovran and Extra Space Storage. The fundamentals are terrific as people are more transient in this decade and thus need storage space. Smart lenders (mostly regional banks) have figured this out and have already jumped on the opportunity and compressed spreads not too far off of more conventional commercial loans. SBA loans are also available for smaller properties.
Student and Senior Housing. Since Fannie Mae finances these products, it is often included with multifamily so I wouldn’t really classify this as an alternate property type with premium pricing. Only speculative developments not adjacent to the campus are ones that are sometimes difficult to finance.
Healthcare. This encompasses medical office buildings, assisted living, nursing homes, Alzheimer and dementia units and hospices. For pure medical office, if it is located on an investment grade hospital campus and thus pre-leased by many of the hospital’s doctors, financing is plentiful. For more of the specialty type products like a nursing home, conventional lenders will sometimes shy away because they view it similar to an operating business like a hotel. In general, though, lenders’ appetites for healthcare financing have increased exponentially. Several years ago, I was looking for the debt and equity for Duke Realty to build the Baylor Cancer Center in Dallas. A life insurance company quickly stepped up and agreed to provide both the debt and equity at very favorable terms.
Marinas. iStar Financial lent over $200 million in 2005 to Yacht Clubs of America to acquire rental marinas in Tampa, Naples and Key West into “dockominiums” where people acquired the warehouse space for their boat. This market crashed in 2008 and hasn’t returned. However, solid rental marinas are trading at around 8 percent cap rates with very minimal upkeep. Aside from the low upkeep, the positives of buying a stodgy old rental marina are that as long as there is power going to the dock and the area is sufficiently dredged, there isn’t much more needed in terms of capital constructions and from a supply standpoint, new construction of a marina is extremely rare. In fact, some marinas were converted to waterfront residential in the last boom thus decreasing supply. For the remaining properties, boat owners therefore have little choice and/or desire to ever switch to another location. Even if they wanted to downsize and cut costs, putting your boat in your backyard is often prohibited by local ordinance. The bottom line is that lenders can generally achieve Libor plus 350 points on a 65-percent-LTV loan on a marina with low risk. It is a fragmented market though with no dominant lender in the space. I’ve financed several over my career with the most recent one being in the Caribbean.
Mobile Home Parks. For the individual mobile home, cheap FHA financing is available. However, for the parks themselves, lenders can achieve above-market returns. Many lenders think of mobile home parks as lower income tenancy and perceive it to be volatile and in tertiary markets. The reality is that many of the trailers stay put for several years or even decades so the downside risk is minimal. In fact, many of the trailers haven’t been moved in several years and might not be able to move even if they wanted to move. Lenders will sometimes get to 70 percent LTV but spreads are often north of LIBOR plus 3 percent. Umpqua Bank and Universal Bank are two banks who specialize in this product, however there are cheaper alternatives if a borrower shops around.
Churches. As it turns out, there are a few lenders that specialize in loans to churches—Thrivent Financial and Union Bank and Trust are two of them. Interest rates are fairly low. However, 270 churches traded hands nationally between 2010 and 2012 (Source: Costar Group) after loan defaults (90 percent due to lender initiated foreclosures). So with church attendance on the decline, this might be a product type to pass over.
Prisons. These are almost always financed with tax-free bonds or other government securities so nothing to see here. With two recent exceptions in New York State, tenants rarely leave abruptly until the end of their lease term.
For yield-hungry lenders, those unusual property types are fertile ground. My contention is that there is a lot less risk in a fully occupied marina, for example, than in a mostly vacant office building where you are simply assuming that leasing velocity in the submarket will continue at its current pace. To generalize, the pricing on the vacant office building is clearly lower in today’s market. Think about that—a lender will accept less yield on a vacant office building than a full marina. Or you could make a hundred loans on office buildings and shopping centers in the Midwest and Southeast at a modest spread and convince yourself that you are properly diversified. But in a regional or sector downturn, all could fall together. Conversely, if you could sprinkle in marinas and mobile home parks at wide spreads, your yields will certainly be far greater, your diversification far greater as the beta in their correlation is negligible, and the additional risk to your portfolio is simply perceived but not necessarily real.
Dan E. Gorczycki is a senior director for Avison Young, where he specializes in acquisition financing, construction loans and joint venture equity raises, often in alternate property types.