Construction Lending Ain’t for Amateurs: Enter CapitalSource’s Tom Whitesell

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In New York, the lender recently teamed up with Atalaya Capital to provide $250 million in construction financing for Flag Luxury Properties’ Ritz-Carlton hotel at 1185 Broadway. 

While L.A. is his home base (Pacific Palisades, to be exact), Commercial Observer caught up with Whitesell while he was in the Big Apple to hear more about his path to CapitalSource, the bicoastal deals that are whetting the lender’s appetite today and what he thinks of the new entrants to the construction lending space.

Commercial Observer: I can tell that you’re passionate about what you do.

Tom Whitesell: I love it. A lot of people think, “Oh, real estate is boring,” and actually most of my family is in the entertainment business, but I love real estate. Everyone’s a character and every day is different, especially in construction and bridge lending. When I first got in the business I was in mortgage banking and we represented life companies on very safe and premier properties. It was a good way to learn real estate lending, but during the [Resolution Trust Corporation] days I realized that the real fun is found in the real estate that has moving parts; whether a distressed property, one that’s in transition or a ground-up construction transaction. Those are the transactions where the money is made and are the most interesting to me.

What do you enjoy the most about your lending segment?

You can create value out of vacant land or take something that’s impaired and make it into something pretty cool. Most of us construction lenders are wannabe developers. Developers are the stars. However, for me, being a construction lender is much more fun and interesting than being the developer. [CapitalSource] will close 60 to 65 loans this year and review hundreds more, whereas a developer takes sometimes five to 10 years to complete a deal. Plus, we get to see everything. As a construction lender, you don’t take on quite as much risk or get the upside, but your breadth of experience is wider and your exposure to varied transactions is so much higher.

How did you get your start in real estate?

I first became interested in real estate when I was at law school [at University of Iowa College of Law]. I learned about leverage in an MBA class on real estate finance there and I thought it was an extremely interesting and powerful concept, so I started studying real estate thereafter. I had never really understood the depth of leverage before then. I liked the concept of juicing your yields to a much more effective level with a limited amount of equity, allowing you to buy more assets by using leverage.

You’ve worked for law firms, banks and debt funds over the duration of your career; how has that mix of experience strengthened your position in today’s market?

I believe that all my background has helped me quite a bit. Going to law school trains you to think differently and approach problems differently. Being involved in loan documentation on the legal side, you understand what is and isn’t important in loan documents. My mortgage banking experience allowed me to appreciate the amount of work a broker has to do to get a loan into a bank. That experience has helped me to better appreciate all the individual players that are involved in a transaction to get it closed. Also, the mortgage banking experience has helped me to understand loan packages and who is presenting a deal to me in a fair honest and somewhat objective way.

You ran Fremont Investment and Loan’s commercial division for 11 years. Is that where you developed your taste for construction lending?

Yes, when I was at Fremont we started providing value-add loan transactions and then we got into ground-up construction. That’s where we learned that there are so many inherent risks in construction lending that you can’t simply dabble in it. You really have to immerse yourself into the construction business, understand it very well and hire strong people to help you underwrite and evaluate transactions.

What is the biggest change you’ve seen in construction lending since then?

I’d say leverage. What we did at Fremont during the last cycle is similar to what we do now, but we’re at a lower leverage [point], which I think is far more appropriate for construction lending. We’re now at 50 to 60 percent loan to cost, whereas in the last cycle we were at 70 to 80 percent loan to cost and sometimes higher.

What’s your take on the new entrants to the construction lending space? Are they equipped?

I think a number of new construction lenders have entered into the market because they see that the yields are better, but they are ill-equipped to understand and underwrite the risks in a construction deal, and to make the monthly draws required on a construction loan. Probably the most important thing a construction lender can do is fund on time every month and be prepared to do it. The new competition we’re seeing isn’t prepared for the headaches and issues you’ll have in a construction loan. Construction lending is very complicated and transactions can be messy. Construction projects do not go exactly as planned, unfortunately. There are always issues in deals; from problems at the beginning with the excavation, to major cost overruns from the increased cost of steel, other materials or lack of labor, to then the potential weakness in a general contractor. Many subcontractors aren’t financially strong so you may have one that goes bankrupt in the middle of your project, and you have to be prepared for that.

Does your extensive experience in construction lending differentiate CapitalSource from the crowd, do you think?

I think having a lot of years under my belt helps. I have overseen over $25 billion of construction loans in my career and I have probably seen just about every problem come up during the course of my career. It does help from the standpoint of understanding and avoiding pitfalls going into deals. It’s also helpful to help the sponsor troubleshoot if they aren’t an experienced developer.

We hear about how overly competitive New York is in terms of deals, is LA any better?

The West Coast is way over-banked. Every market feels like there is no lack of lenders out there providing quotes and trying to structure deals. And I think L.A. is just as bad as New York, maybe more competitive.

What attracted you to the role at CapitalSource five years ago?

The CEO is from Iowa and I am from Iowa [laughs]. I liked him, he asked if I wanted to start a platform at CapitalSource and I said “Sure.” He had the appetite and desire to build a construction business platform, and when you have senior management supporting the business you want to do that’s a very positive thing.

The timing was also very good because there were very few lenders doing non-recourse construction lending at the time. The economy had been getting stronger so it made sense to be a construction lender in our minds. The risk at that time and shortly after we started was that the High Velocity Commercial Real Estate (HVCRE) rules came into effect and created more complications to underwriting and structuring construction deals. But at the same time, HVCRE regulation further limited the number of players providing construction loans.

How has your construction loan volume grown over the years?

We started off during our first year doing $300 million and we have grown steadily to $1.5 billion in loans per year. We’re focused on steady and smart growth on the construction side of the business. We don’t want to be the biggest, just the best. We built our team gradually, and we walked before we ran.

Which asset types do you prefer?

The most prevalent deals we do are multifamily. We do both for-rent and in selected markets we’ll do condominium construction as well. We love student housing around large universities and we’ve done a number of office transactions. With hospitality we are very selective. Industrial is a product type we really like as well. We have stayed away from retail in this current cycle.

You’ve said in the past that your sweet spot in terms of loan size is $50 million to $75 million loans, although you’ll lend up to $150 million. As a senior lender, how important is it for you to have a strong mezz or preferred equity lender behind you in the capital stack?

It’s very important. As I said, in the last cycle leverage was around 80 percent loan-to-cost on our loans, but today the senior lender is between 50 and 60 percent loan-to-cost typically. So, you need to fill that gap up to 80 percent because most borrowers aren’t going to put in 40 or 50 percent cash in the deal. Mezz or preferred equity providers—they’re effectively interchangeable—fill from our last dollar up to 70 to 80 percent. We look for those who are institutional in nature and have been in the business for a number of years. We like those who are experienced in owning and managing real estate and we work with a dozen or so quite often, doing repeat business with them.

How much of CapitalSource’s lending activity is on the East Coast, versus West Coast?

For our construction business we’re almost at 50/50. We have a very strong presence on the bridge lending side on the East Coast, in New York, Chevy Chase [Md.] and Orlando. So we’ve always done a lot of bridge lending there, while our construction lending has increased over the past couple of years.

How are you dealing with the crazily competitive bridge lending space?

Bridge lending is much more competitive than construction lending, there are so many lenders in that space between the banks and debt funds. How we compete is by focusing on relationships and working with repeat borrowers as much as possible. Once they’ve done business with us hopefully they have a great experience and a smooth transaction, allowing them to have certainty that they have a lender who is a partner for them for the next transaction.

Are most bridge borrowers executing their business plans on schedule?

On the bridge lending side, most of our borrowers are completing their business plans on time and on budget. On the construction side it’s a little harder as everything gets delayed and costs continue to increase.

We’re hearing that bridge loans are frequently being refinanced by another bridge lender.

Yes, a bridge to a bridge. And that bridge lender could be a bank or a debt fund, there’s so much competition out there for that loan.

When it comes to condominium construction lending, is your decision-making process more sponsor-driven or market-driven?

Both borrower and market, I’d say. There are just a few markets we’ll do that type of lending in. We didn’t do one condominium project in Florida this cycle because there were so many issues last time around, and it became so competitive down there that we decided that we couldn’t get paid for the risk we’re taking, so we have stayed away. We have done a number of deals in Manhattan and surrounding boroughs, but the deals we are doing are “affordable,” meaning under $3 million. So we have not provided loans on any deals that have properties that sell above that price. We’re focused on affordable product that sells, and sell quickly. The product under $2 million certainly sells very quickly in this market. Today it may have slowed down a little but it’s still selling, whereas the $5 million and up product is not and so we’ve completely stayed away from that business. We haven’t done a condominium deal in L.A. We’ve done some in D.C. and we’re probably going to do one or two up in the San Francisco Bay area and Seattle. Again, we’re looking at the affordable projects only.

Is the challenge of the deal what you enjoy the most?

There are a few things. There’s the thrill of underwriting, structuring the deal and getting it signed up. Then there’s the thrill of negotiation and fighting through any issues before closing the loan from the origination standpoint. Lastly, there’s watching the business plan come to fruition. So there are a number milestones and mini celebrations along the way, and when you have 60 going on throughout the year there’s a lot to get excited about every day.

What keeps you up at night, from a market perspective?

Honestly, the fundamentals of the market feel pretty good from the standpoint of construction deals, which are taking longer and longer to get done. While everyone says the pipeline is full of new deals, many won’t actually come to fruition. So, I’m not so concerned about overall market fundamentals. My biggest concern is the cost of construction. Materials have increased in price but labor is the biggest problem right now. We just don’t have enough labor to go around to get jobs done, and so the cost goes up and up. The tariffs are going to be an issue as well.

On the bridge lending side of the business leverage is starting to creep up higher and higher. You can no longer win deals at 60 percent you have to be at 65 percent. That causes me concern, because leverage is always an issue.

Any lending predictions for 2019?

I think on the bridge lending side we’ll see less transactions because there is more competition and it’s harder to find business. On the construction side there will also be less transactions and some won’t be able to compete because equity investors won’t think they receive the returns they want. That will provide a challenge for developers to get projects completed.

What advice would you give someone entering the industry today?

This is what I tell my daughters: Show up earlier and leave later than everyone else. Work harder than everyone else, keep your eyes open and you’ll do extremely well. Watch the more experienced people and mimic their good skills and attributes that can fit your personality. Figure out what you are passionate about and do that work. That way when you go to “work,” it isn’t.

What do you do in your spare time for fun?

I’m trying to be a good golfer. That is my goal for 2018 and 2019.

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