Brains & Braun: SL Green’s David Schonbraun on His New York Lending Strategy

As a result, Schonbraun, the co-chief investment officer for Gotham’s largest office landlord, and his team cherry-pick the lending opportunities that are the best fit for the company, selling positions along the way to keep the book balanced. Weighing in at No. 27 on Commercial Observer’s Power 50 list (see page 42), Schonbraun had quite the year in 2017, running SL Green’s side of its and RXR Realty’s purchase of a 49 percent stake in Worldwide Plaza. And like a lot of athletes, he has the stamina to keep going. He gave CO the low-down on which transactions have piqued his team’s interest lately.

Commercial Observer: Congratulations on being on the Power 50 list! How was 2017 for you, overall?

David Schonbraun: Our main focus is always to work to optimize our book…We maximize profit by limiting risk and, with that, run a $200-plus-million revenue business. Last year, we picked good spots for us to invest in—so projects that we really liked with very good sponsors. And one of the trademarks of our business is that we were one of the first groups to have the strategy of taking down the whole loan—or the larger piece of a loan—and then syndicating it out to enhance our yields. It’s very important for us to constantly be evolving our strategies as the market changes, especially in the debt business.

How has your strategy evolved since joining SL Green in 2002?

When we started this business within the REIT, our focus was really on buying subordinate debt. As we grew and the markets changed, we began co-originating, then originating by ourselves and syndicating. Now we’re holding whole loans more and financing them through repo facilities. We’re always trying to evolve the business to stay one step ahead because there are so many more competitors in the market now. We look to where the inefficiency is in the market, and that’s where we think we’ll make the most money.

Where do you see that inefficiency right now?

This is the most efficient market we’ve seen, unfortunately [laughs]. There’s so much capital. We’re focusing on using our relationships and being quick to get deals. We still have a big advantage with transitional assets, given our real estate background. A lot of sponsors—and it may be counterintuitive—prefer us to be in the more complicated deals with some redevelopment and leasing because as their business plans change they know they can come to us and say, “Look, we know this wasn’t on the initial plan, but as we’re looking at the market, we’ve re-evaluated, here’s how we think we should change it.” From a real estate perspective, we can understand those assets quickly and say, “That wasn’t the original plan, maybe it’s more expensive, but we think it makes sense,” or, “We understand you may have to sign a lease to less than underwriting to get the momentum in your leasing and you’ll make it up on the back end,” whereas a lot of pure lenders don’t understand that and are stuck in their model. So, I think in any real value-add real estate, I think we have a big advantage in working with clients. We view ourselves as partners with our borrowers on that.

The transitional space is extremely competitive right now.

Yes, but we’ve always been in that space. Some of the foreign capital is doing the cheap, 10-year fixed-rate [mezzanine lending], and that’s not a space we want to play in as much. Sometimes we’ll take down a mezz loan, sell pieces and lever up that way to get a yield that works for us, but otherwise we’re really looking for better yields for ourselves, and the transitional space tends to be a good fit us.

You provided a $110 million mezzanine loan on 245 Park Avenue and sold part of it. Are you looking at 245 Park again as a potential acquisition now that it’s back on the market?

We look at every asset that’s on the market, and we’re always looking to invest in a way that makes money. We always have conversations. But, for now, we’re a lender and we’re very happy being a lender.

That deal is a perfect example in terms of how we tried to buy [the property], and [HNA] paid a higher price than we were willing to. But when they lined up their financing—because we’d already done all the underwriting—we could quickly commit to doing the bottom mezzanine loan. So, early on that guaranteed us a position in the capital stack. The banks like it because they’re able to sell their bonds and their senior mezz at a lower rate with us as the anchor in the capital stack. And then, to enhance our yield, we sold a piece of our loan off. So it’s kind of a win-win for everyone; the bank that originated the loan gets a better execution with us anchoring and selling the pieces, and we were able to hold what we want, syndicate off a piece and get an above-market return.

Has barbell lending been a consistent strategy for SL Green? 

We’ve always kind of looked to run the business that way. For us, we try to have a blended yield, and in doing that we can do some higher-yielding stuff and some lower-yielding. It allows us to play where we want in each capital stack and at the right risk point. So there are a lot of deals where lenders are junior to us in the transaction, and a lot of people will view us as a first loss, and a lot of times we are. But there are a significant number of other deals where we take a more senior piece of the stack because, for us, that’s the better risk-adjusted return.

How are you choosing the “good spots” in the market and identifying potential opportunities?

Right now, we’re not growing the size of our book significantly. What that enables us to do is seek out transactions where we like the sponsor, the real estate and the basis. We do those deals and then look within our own portfolio and start selling off some other assets we’ve originated. If we can originate a loan on a new vintage at a little higher yield than something we’re selling, it makes the company a little bit more incremental money. Hopefully, we like the credit on the loans we’re [adding] a little more than those we’re selling, or they’re higher yielding but the same credit. We’re always looking to optimize the book.

Tell us about 888 Broadway. Why were you attracted to that particular financing opportunity?

It’s a great location and a great piece of real estate with two very good sponsors. We have a great relationship with Normandy [Real Estate]. They’re great guys and very good operators. We really believed in their business plan for the asset and think it’s going to be an incredibly successful project. It’s a typical transaction where there’s going to be redevelopment and a lot of lease-up, and if they have to come back and change their plans, they know that we’ll be very flexible with them.

Are there any examples of that flexibility you can give us?

For RFR on 285 Madison Avenue, as they got into the project, the scope of the project changed. We thought it was the right thing for the property, so not only did we say, “We agree with what you’re doing, but we’re also happy to upsize our loan to allow it and help fund it because we think it’s right for the project,” and we gave them additional capital to do that.

RXR has been upping its lending activities, joint venturing recently with a Canadian pension fund to do so. What’s the draw is in increasing that activity for New York City owners?

I think it’s driven by the strong desire for institutional capital to be investing in real estate right now. There’s not as much sales activity and so they use the debt space to get real estate exposure and returns.

Is the bid-ask spread still buoying sales?

I don’t think it’s so much that bid-ask spread is so wide, as much as over half the stock of New York City office buildings are owned by a handful of well-capitalized institutions. If they don’t see opportunity to reinvest their capital somewhere else, they’re not going to sell for the sake of selling and then sit on cash. We’ve sold assets to buy back stock and if we didn’t see that opportunity maybe we wouldn’t be as aggressive in selling assets. You’re also seeing some joint ventures because some people want to sell a little bit and have some need for reinvestment. I think a lot of it is driven by a lack of reinvestment opportunity.

That’s good news for the debt side, in terms of increased recapitalizations?

It is, and it isn’t. It’s good in terms of you’ll see a lot more recaps like you saw on 237 Park [Avenue] last year. One of the partners wanted to sell, but they got such attractive financing they said, “You know what, there’s really no reason to sell because this financing is so attractive it’s really not worth exiting.” We were in that loan but got paid off. So, it’s good from that perspective. But part of the spread compression is there’s so much money chasing not as many deals, and if the sales market had a little more transaction volume, you’d probably have a little more easing just because there’d be more financing.

It seems like last year was truly the year of competition.

Yes, and I think it’s even more competitive now. We’ve seen spreads come in significantly, and there are more people raising money to compete in the spaces, so it’s maybe even oversaturated right now. The pricing has come down and we have to work a little bit harder through syndications to get the yields we want.

How has the syndication side of the market evolved?

I just think the capital is much cheaper, so it used to be that you could take down a loan and there was a significant amount of room in the spread you were getting to syndicate out and get a good deal for yourself. Now, the capital stack and the pricing is so much tighter, you have to be right on top of the pricing when you’re going to sell more inventory or a mezz piece. There’s much less room for error in judging exactly where the capital markets are.

Are you seeing discipline slide anywhere in the lending market?

The only place we see a little less discipline is on refinancings on new acquisitions. When market value is pegged, I think it’s a lot clearer with refinancings when certain nondomestic or newer lenders are looking at appraised values but lending at a higher value. But, it’s still a very controlled market, and you haven’t seen as many financings where borrowers are looking to get very high leverage.

And borrowers are also being pretty disciplined, correct?

It’s a much more equitized market, which is good, as people are really stretching out financings. It leads to a few less mezz opportunities, but for a market as a whole it’s much healthier.

SL Green’s big acquisition last year was Worldwide Plaza. What appealed there?

It’s a Class-A building and we wanted a little more exposure on the West Side. We got in at a very good basis, a very good cap rate. If you look at our returns on a fee-enhanced basis, they were extremely attractive versus anything else we were seeing in the market. So, [it was] a Class-A building at a low basis and [in] an area on West Side [where] we wanted to be, with a great tenant roster. [And the fact that] we thought it was kind of an above-market attractive yield was great for us. It was also good to team up with RXR, with whom we have a great relationship.

Any specific strategy you’re working on for 2018?

We look every year to sell a couple of assets and then find the best way to redeploy that capital from a lending standpoint. We try to manage that to about 10 percent of the company’s assets but always optimizing, working on risk-adjustment return, duration and then finding the best projects and the best borrowers. So, I think that strategy stays throughout the cycle for us.

How many opportunities would you say come to your desk every year?

I would say hundreds of opportunities come across. You don’t dig deep on a lot of them. We really quickly kind of weed out the ones we think are right for us and then focus on them. One of the reasons is that we’ve underwritten almost every asset in New York already, know it and have a view. We generally already have a value on the building, so we can quickly look at it. We know exactly what we’re looking for.

Has SL Green’s debt business always been 10 percent of the company? Do you see it increasing at some point?

It’s been pretty steady for the past decade or so, so I think as a public equity REIT that’s the right level to keep it at. And, in some ways, it doesn’t force us to do transactions the way it does for other people. We have the ability to really just choose the transactions we think are best, and we aren’t forced to put out capital.

Given how busy you are, do you still have time to play tennis?

I do [laughs]. I’ve started playing much more frequently. My kids play, so I’ve started getting more into it.

So they take after you?

They do. The oldest one [9] is playing tournaments, and she’s doing really well. My little guy loves it—and is excellent for a 6-year-old—my 3-year-old has not gotten into it. Yet. What’s interesting is [Fried Frank’s] John Mechanic hosts a lot of tennis games. I’ve played with him a lot. He introduced me to a lot of people in the industry when I was just starting out, and through him, I was fortunate enough to meet a lot of people.

Do you have any career mentors?

My father was in the real estate business—he had an accounting and consulting business—so from a young age I got to learn from him. I grew up listening to his phone calls with people talking about real estate deals and how to structure things. At my first job at Credit Suisse I worked with David Genovese, who—lucky for me—took a big interest in my wellbeing. He would allow me to sit in when we were working on selling properties. I came [to SL Green] in my mid-20s and have been beyond fortunate to work for Andrew [Mathias] and Marc [Holliday]. They’re the best in the industry, and the amount they have taught me is invaluable.

Is your dad happy with your career choices?

He is. I’ve been very fortunate. I’ve worked hard but was at the right companies with the right guys, and it’s worked out pretty well.