Although some increased caution in the current lending environment is inevitable, regardless of lender or property type, the music hasn't stopped – or even slowed – for certain market players. This week, MortgageOrb spoke with Josh Zegen, co-founder and managing partner of Madison Realty Capital, on the effects of liquidity and securitization issues on private-money bridge lenders, many of which now find themselves in a uniquely strong position.
Q: Firms like yours – private-money bridge lenders that keep loans on their balance sheets – seem to benefiting right now from the smaller lending market as a result of the credit crunch and struggles with loan securitization. How will borrower demand shift when conduit lenders do come back? What changes do you anticipate making to reposition yourself in the new market – especially if other lenders can provide deals at more attractive rates?
Zegen: A lot of our market is very time-sensitive transactions, and even in the most competitive lending market, there's always need for fast money: Someone may need to close a transaction, and the banks fall short.
We have certain flexibility in rates depending on deals and depending on the times. We were lending more cheaply in the competitive market, but we don't really have to today. It's more of a lenders' market.
Q: When you evaluate potential deals, how crucial are asset characteristics relative to borrower qualities? What sorts of property characteristics do you generally require or favor, and have those requirements become more stringent in recent months?
Zegen: In the past, we were very asset-based, but now, because exit strategies are not as clear today, the borrower is very important as well, in terms of credit quality, his ability to refinance, or his ability to sell that asset. We're really looking closely at the borrower as well as the property, and that's something that's changed.
In addition, we're looking at lower leverage points. In the more competitive lending market, everyone was lending at more aggressive numbers, but today, we're able to lend at less aggressive loan-to-values, just because borrowers are willing to put up other collateral, and they're willing to come in with more equity.
We always traditionally have liked income-producing properties, but now, as I evaluate deals, I may [consider] where cap rates are going to be in the next year. If anything, there is an upward trend in cap rates because the ability to finance a property is that much harder today. We're underwriting things more conservatively.
Q: Looking across the spectrum of commercial real estate, what sectors do you see as the strongest right now? Which pose the greatest cause for concern in 2008?
Zegen: The hottest asset type still is multifamily rentals. I think that will continue. Some of the areas that may be more subject to problems in the near future are the retail sector, the hotel sector, and some areas of the office sector, depending on where that property is.
But if the overall economy goes into a recession, then one of the first areas to get hit is retail. With office, you're seeing a big pullback in business spending, and one of the first areas of pullback is expansion. Hotel goes with that.
You are seeing – in certain markets, like Florida, where there was definitely an overbuilding of condos – a lot of the projects going back to rentals. You're looking at markets that have very high occupancy rates, but the lenders are looking to the next few years and saying occupancy is not going to be as high because of the competition. Then it comes down to quality of the project.
Overall, though, if you have people who are not going to be able to buy [a single-family home], they are going to be renting – because they have to live somewhere.
Q: Transaction features like interest-only and high leverage seem to have all but disappeared these days. Do you consider these too risky in the current environment? Have you changed your general structuring policies or restricted availability to the riskiest structures?
Zegen: In terms of structuring, we are lending at lower-leverage numbers than we were. Traditionally, our fund goes up to 75% loan-to-value. Today, although we're lending at 75% on some deals, once again, it comes down to the quality of the borrower: his ability to repay and his balance sheet. There's more looking at the overall picture when we're going to go to the highest-leverage numbers because the ability to get refinanced is not as great.
The other lenders that were going up to 80% loan-to-value are [now] doing 65%, and the mezz lenders who went up to 90% are now going to 75%.
Interest-only from a securitized lender is not as easy: At the height of the market, they were underwriting 10-year interest-only. I don't believe that exists today, for the most part. You may be able to get very short interest-only periods as part of longer-term deals. However, our deals are still interest-only. In the floating-rate environment, that has not changed.
Q: The constant question right now is whether the country will enter a recession: Based on what you've heard and observed in the industry, what do you think? Has your firm taken any protective measures yet?
Zegen: We're more likely than not to go into a recession in the next six months, but I don't necessarily think it's going to be a long-lasting recession. The housing market is definitely getting worse, and the credit markets – over the last 60 days – seem to have gotten worse. The investment banks dropped out earlier in the credit crunch. What has happened recently is that you're even seeing some of the savings banks pulling back a bit in the market.
We are still actively lending, but we're cautiously optimistic in the market. We're certainly looking at the borrower's ability to repay rather than just saying, ‘Well, if I have to own it, I own it.’ We used to take more of an asset-based lending approach. Today, we're real estate-focused – but borrower-focused as well.
