A Look into Financing LA’s Deals

By Dennis Kaiser

Connect Real Estate Los Angeles featured a full afternoon of conversations, networking and presentations. More than 500 gathered at the Hotel Indigo in DTLA, and heard from commercial real estate leaders and economists about the trends driving decisions in Los Angeles.

Today, we recap the finance conversation between experts from across the capital stack. Financiers discussed the drivers, obstacles, and financing programs borrowers want. They took a look at what’s succeeding, what’s changing, and what financiers see for the year ahead for the LA market.

Walker & Dunlop’s By Cartmell set up the finance discussion, noting that for those in the lending business for the last five years, Los Angeles has been as “good as it gets.” Given the supply and demand numbers across the basin, “from a lenders point of view, this is the best [market] we can think of,” he said.

George Smith Partners’ Gary M. Tenzer noted that they are seeing a “typical mix of business,” with a steady flow of deals that aren’t slowing down. He expects to do a similar volume as last year on both the debt and equity sides in 2018, though strategies may have changed in an increasing interest rate market. He is seeing investors replace fixed loans, pull out cash and lock in new 10-year fixed rate deals to “protect against upward trending risk.” Tenzer sees more of those types of strategies being executed this year.

 He notes debt funds are “very active” and spreads are coming in at an “aggressive stance.” Tenzer pointed out there’s a little bit of caution on the horizon as investors see some overbuilding in some submarkets, such as DTLA where it could be difficult to get a high-rise multifamily development financed today. Borrowers may have to do a lower leverage deal, since lenders sense it is getting “late in the cycle.”

CapitalSource’s Tom Whitesell agrees on the construction side, lenders are steering clear of some SoCal markets, such as DTLA, since they see too much luxury multifamily coming. He questions if there is sufficient demand to support the price points. On the other hand, he notes there is a “big need for multifamily overall in the SoCal basin.” Whitesell points out that at $2,000 to $3,000 per month rents, workforce housing gets leased up overnight because there is such a need for it.

 Realtymogul.com’s Elizabeth Braman says on the equity side she is seeing leverage getting pulled back on many transactions in major metros because there isn’t cash there, or due to heavy rehab components, lenders are electing to pull back given the rising interest rate environment. That said, she notes the larger deals in Los Angeles typically attract institutional or international capital that tends to be more patient, is more comfortable with a low cap rate transaction, is fine with a longer hold and isn’t looking for cash flow early on. 

Tenzer says, institutional investors prefer two types of properties today, multifamily and well-located industrial. Hotels were strong, but he sees this product type slipping into a bit more of “yellow light category,” given new supply and competition with the likes of Airbnb. “Retail has fallen out of favor,” notes Tenzer, “but industrial, that’s incredibly strong, if you can find good industrial, it’s golden.”

Hunt Mortgage Group’s Peter Clasquin said that the interest rate increases have been offset by rent increases. As a result, “this year we are doing a ton of supplemental loans.” He notes the keys to the company’s success has been to find “better borrowers” and adhere to “better underwriting standards that are better than ever.” He points out a reason for that strength is the fact “we can look at cash flow 10 years from now” for properties based on job and income growth. “It is a more robust model now,” he says. In today’s market, Clasquin would recommend doing a step pre-pay deal, because if the borrower is outside a year of maturity the penalty is in double digits.

This year, Clasquin believes it will be a “stay the course” pattern given how agencies are underwriting multifamily loans. Yet, due to the flattening of the yield curve, he’s seeing longer paper requests. Of concern to him is how the Fed’s shedding of $4.5 trillion worth of debt will affect rates and values.

CapitalSource’s Whitesell said the new proposed HVCRE regulations should help clear up “confusion in the market” about how the rules to limit construction loans were being applied. Each regulator approached lenders how they saw fit, often “treating them differently or a little unfairly.” The HVCRE rules forced more equity capital into deals. That has been a big challenge for developers, notes Whitesell. The new regulations “will bring clarity” to the lending market, though could attract more competition to the market.

Check out previous coverage of Connect LA panels:

Buy, Build, Sell, or Hold: Investment & Development Insights

Economic Forecast: Jobs, Policy, Pricing & Real Estate

Brokerage Leadership Insights: A View from the Top

For comments, questions or concerns, please contact Dennis Kaiser