For J.H. Snyder Co. to start building a $197 million Los Angeles apartment complex in June, the developer cobbled together funds from two city agencies, a mezzanine lender and a pension fund to help fill a 63 percent funding gap left by JPMorgan Chase & Co. (JPM)’s construction loan.
“The structuring of this deal has been one of the most complex I’ve seen,” Thomas Dujovne, chief investment officer at Los Angeles-based J.H. Snyder, and a 17-year veteran of the industry, said in a telephone interview.
Snyder’s 397,000-square-foot (37,000 square meters) residential and retail project is typical of a broken funding market globally for commercial real estate construction. Banks are cutting lending from Sydney to London to Los Angeles as they cope with the after-effects of the 2008 financial crisis that’s left them with debt arranged before property markets crashed, and as they navigate Europe’s fiscal issues.
That’s restraining construction and forcing developers to fill the funding gap by turning to real estate investment trusts such as Starwood Property Trust Inc. (STWD), sovereign wealth funds and public pension funds, even if it means greater risk, higher costs and additional time to arrange financing.
The amount of new lending for European commercial real estate fell by about 77 percent from 2007 through 2011, according to estimates from Michael Haddock, research director for CBRE (CBG) Group Inc. That’s partly because banks are only willing to lend on more conservative loan-to-value ratios and also because some investors have bought properties using little or no debt, Haddock said in a telephone interview.
The withdrawal of banks from commercial-property lending in Australia is the “most significant change” since the collapse of Lehman Brothers Holdings Inc. in 2008 froze credit markets, the Reserve Bank of Australia said in May. Australian banks have cut outstanding loans for commercial real estate by 15 percent since the peak in 2009, the central bank said.
Outstanding housing and land development lending in China by major financial institutions slowed on an annual basis for three consecutive years starting in 2009, according to the People’s Bank of China.
As bank credit has tightened, real estate trusts, which attract money from wealthy Chinese to property projects by offering higher returns, more than doubled from the level on March 31, 2010, to 605.2 billion yuan ($95.3 billion) as of June 30, 2011, and further climbed to 675.1 billion yuan as of June 30, 2012, according to Ping An Trust & Investment Co.
In the U.S., the world’s largest economy, construction and development loans on the books of the 7,307 banks backed by the Federal Deposit Insurance Corp. totaled $228.3 billion in the first quarter, a 23 percent decrease from the year earlier.
“Construction funding today is market specific, sponsor specific and project-type specific,” Bruce Beal Jr., executive vice president of New York-based Related Cos., said in a telephone interview. “When capital was easily available, banks were eager to lend. Today, money to fill that funding gap is coming from a variety of places.”
J.H. Snyder’s 464-unit residential-and-retail project in Los Angeles was financed in part by JPMorgan’s $72.5 million construction loan. J.H. Snyder and Washington Capital Management, a Seattle-based pension-fund manager, provided $41 million in equity, according to Dujovne.
They also stitched together a $12.5 million loan from the city of Los Angeles and a $5 million loan from the local Community Redevelopment Agency. Canada’s Bentall Kennedy, which is partly owned by the California Public Employees’ Retirement System and British Columbia Investment Management Corp., provided $66 million in mezzanine debt, which is secured by a stake in the development.
In Chicago, Hines, an international property investor, is building a 45-story building with help from Canada’s Caisse de Depot et Placement du Quebec, through its real estate investment arm Ivanhoe Cambridge. The $300 million skyscraper, constructed downtown on the western bank of the Chicago River at Lake Street, will be the city’s biggest real estate project in the past five years, according to Mayor Rahm Emanuel.
The tower, being built without debt, will sit on land co-owned by a Hines joint venture, giving it a 15 percent stake in the investment. The pension will hold the rest. Hines declined to comment on whether it had looked for financing from banks or other lenders before striking a deal with the pension fund, said spokesman Eric Gerard with New York-based Great Ink Communications.
“The availability of construction debt is far less than it’s ever been,” said Brian Stoffers, chief operating officer of broker CBRE’s capital-markets unit and president of its debt and equity finance divisions, based in Houston.
CBRE, based in Los Angeles, arranged 18 U.S. construction loans totaling about $500 million in the first half of this year, down from 35 development loans totaling $1.5 billion in the first half of 2007. Most of the loans this year capped off at about 55 percent to 60 percent of total development costs, according to Stoffers. That’s down from loan-to-values of about 74 percent at the peak of the commercial real estate market, in 2007, he said.
A pullback by banks means firms can earn returns of 10 percent to 12 percent for mezzanine construction financing, according to Boyd Fellows, president of Greenwich, Connecticut-based Starwood Property.
The REIT, founded by Barry Sternlicht, provided a $170 million first, senior mortgage in May for One Soho Square in downtown Manhattan. The initial funding of $135 million with the balance available for future tenant improvements will be used to gut and renovate an office building into an office-and-retail property.
The firm is also looking for construction-funding opportunities in large cities such as Boston and Washington, and will soon complete mezzanine funding for a residential development in London, Fellows said.
It’s less likely to run into competition from banks. In the U.K., banks for the first time in at least 11 years are unwilling to finance development projects without a tenant committed to lease space or a buyer for the completed property, according to a study by De Montfort University. One in three lenders in the U.K. didn’t make a single commercial property loan last year, Bill Maxted and Trudi Porter said in a survey by the university published in May.
That shortfall is being filled more frequently from the Middle East. Development finance “seemed to ramp up quite steeply” about two years ago, said Peter Rees, chief planning officer at the City of London. The Shard, across the river Thames from London’s financial district, is an example “of the sort of thing that Middle Eastern sovereign-wealth funds were looking for. They wanted something showy.”
Qatar’s central bank owns 95 percent of the tower, and Qatar National Bank, 50 percent owned by the country’s sovereign-wealth fund, provided an undisclosed amount of funding for its construction.
The tower and its neighboring London building, The Place, together may be worth about 2.5 billion pounds ($3.96 billion) when they are fully leased, said Irvine Sellar, chairman of Sellar Property Group Ltd., which owns 5 percent of the building. The properties will cost about 1.5 billion pounds to construct, including land costs and interest on the debt.
“Development has the balance of risk and reward,” Sellar said. There is debt available for new buildings “but not nearly as much as in normal times. It’s limited and it’s mainly concentrated on residential.”
Normal speculative development completion patterns are not likely to return to Europe for the next five years, Jones Lang LaSalle Inc. said in an Aug. 28 note.
Europe’s banks have as much as 2.4 trillion euros ($3 trillion) of loans outstanding to real estate companies, accounting for about 10 percent of the loans on their books, Morgan Stanley (MS) wrote in a March 15 research note. They’ll cut their exposure by as much as 600 billion euros, the bank estimated, as they work to meet proposed capital regulations under an agreement approved by the Basel Committee on Banking Supervision, or Basel III, and deal with Europe’s sovereign-debt crisis. That will open up opportunities for “niche players,” according to the Morgan Stanley note.
Financing such as that provided by pension and sovereign-wealth funds tends to mature later than the five-year loans given by banks, Rees said. Axa Real Estate Investment Managers will give loans for as long as seven years, according to Isabelle Scemama, head of commercial real-estate finance at the fund manager.
Alternative funding often comes at a higher cost for developers than what conventional construction lenders used to charge, according to Chris Mutch, a real estate director at PricewaterhouseCoopers LLP. They “will add premiums for development more so than what the banks did, whether through fees or interest margin,” Mutch, who is advising funds raising money for real estate investment, said in an e-mail.
“Interest rates will inevitably rise, stoked by current quantitative easing programs and an eventual economic recovery,” Benoit du Passage, managing director of Jones Lang for France and southern Europe, said in the August note. Constructing office buildings may be “more stable” than other types of development because of the financial strength of tenants. “Some developers may look back in a few years and reflect on a missed opportunity if they don’t act quickly,” he said.
In Australia, the cost of financing is also higher -- about 8.5 percent on average, compared with about 6 percent for bank debt, according to Peter Icklow, chief executive officer of Sydney-based property developer Monarch Investments.
A lack of financing has contributed to the value of building work dropping by 5.8 percent in the second quarter from a year earlier, according to the latest data from the Australian Bureau of Statistics.
It has also led to a drop in permits for new construction in Australia. The value of approvals for future building work slumped 19.5 percent in July, extending a 11 percent decline in the two years to ended June 30, statistics bureau data shows.
Perpetual Ltd. (PPT) and Balmain Funds Management are among those raising capital from institutions to lend to local real estate companies for acquisitions and to commercial and residential developers.
Monarch Investments received its first investment from a debt syndicate at the end of 2011. Two funds representing private investors have injected a total of A$7 million ($7.2 million) into projects worth A$15 million being developed by Monarch, CEO Icklow said. The company is in talks with other funds on investments of A$20 million to A$50 million, he said, declining to name the potential investors.
Balmain is seeking as much as A$500 million in a joint venture with investment adviser Brookvine Pty to lend to real estate developers and companies that own and manage commercial real estate, Michael Holm, executive chairman of Balmain, said in an interview in Sydney. That’s double its initial target, he said.
“Investors are now starting to put their toes in the water,” Monarch’s Icklow said in an interview. “Without them we wouldn’t be doing any new development.”
Seeking new sources of financing adds to the time it takes to start a project, which can jeopardize profits, said Richard Green, director of the University of Southern California’s Lusk Center for Real Estate in Los Angeles.
“If you have equity partners, you as the developer don’t get paid until you meet certain benchmarks,” Green said in a telephone interview. “And the longer it takes to arrange financing, the longer it will take to start building, the longer you go without renting and the longer you need to hit those benchmarks. Every day eats away at a developer’s profits.”
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