Lending Trends

July 9th, 2014

Lending Trends

As published in Western Real Estate Business:


Western Real Estate Business gathered four of the West’s top lending experts to discuss the region’s most prominent financing trends. From SBA to CMBS, maturing loans to deal flow, these professionals cover it all.


We all know it hasn’t been easy for small businesses to access financing. We read stories in the news everyday about small businesses struggling to compete, to purchase their own office or shop, make building improvements, or purchase much-needed equipment that will keep them competitive.

Access to capital is essential if a business intends to purchase real estate. It is often an uphill battle for businesses that require specialty properties, for those that have been in business for less than two years, or for those that require significant renovations or ground-up construction. Affordable financing is not easy to find, but it is available, thanks to the SBA programs. The U.S. Small Business Administration (SBA) was created to combat the economic challenges facing many growing small- and mid-sized businesses. The SBA released two significant changes to the 504 and 7(a) loan programs this past April. These revisions make it easier for businesses to qualify for affordable financing with a low down payment, which enables businesses to create jobs and strengthen local economies across the U.S.

Recent SBA Program Changes

The first, and perhaps most significant change, is the elimination of the personal resource test. SBA’s eligibility criteria have historically restricted high-net-worth individuals from participating in an SBA loan. The original idea was to filter out owners who had access to additional financing resources and did not need a government- supported loan. In reality, many businesses with wealthy owners still struggle to find financing. The second change, which only affects the SBA 504 loan, broadens the timeframe allowed for business owners to justify expenditures already invested in a project. The old rule capped the eligible costs within a nine-month window before the loan is approved. Owners can now roll eligible expenses that were incurred beyond nine months into their financing package. As long as the costs relate to the project and would not be considered refinanced debt, these expenses can usually be rolled into the loan and may reduce the borrower’s cash injection. Business owners who need to make quick decisions about capital investments can now take immediate action before their SBA 504 loan is fully approved. Some restrictions apply, so it is important that business owners discuss their plans with their local Certified Development Company (CDC) to ensure maximum upfront capital investments can be recouped.

What are 7(A) and 504 Loans?

The 7(a) loan is an SBA guaranteed loan designed to increase access to capital for small- and mid-sized businesses. A bank provides financing and the SBA guarantees up to 85 percent of the bank’s loan. This allows banks to provide more aggressive rates and terms to small businesses. The money can be used for a variety of business uses, including business acquisition, working capital, inventory and real estate. The maximum amount of an SBA 7a loan is $5 million. The SBA 504 program is an economic development program, created to help these companies grow and create jobs. In the U.S. today, two out of every three new jobs are created by small businesses. The 504 program enables companies to retain their working capital so they can continue to grow and create jobs. Broadening the eligibility parameters makes SBA financing available to more businesses. Money from the 504 program can be used for commercial real estate, construction and equipment. The financing is split between a bank and a Certified Development Company. CDCs are certified by the SBA to provide SBA 504 loans. All SBA 504 loans require the partnership of a lender and a CDC. The key benefits of an SBA 504 loan include the ability to access up to 90 percent financing (with as little as 10 percent down) and a below-market fixed interest rate. This financing is achieved with a bank first mortgage, usually at 50 percent of the project, an SBA second mortgage, usually 40 percent of the project, along with a 10 percent cash injection. The maximum 504 loan is up to $5.5 million per project (restrictions apply) and there is no limit to the bank’s loan and, therefore, no limit to the total financing package.

This loan compares favorably to conventional real estate financing, which usually requires a 20 to 30 percent cash down payment. With a down payment as low as 10 percent, businesses can maintain liquidity and reinvest capital in new jobs and business growth. In addition to preserving working capital, SBA 504 loans provide the advantage of having no balloon payments or additional collateral required in the loan. In fact, one of the recent SBA 504 changes encourages CDCs to limit collateral to the SBA’s second lien on the subject property whenever possible, even if the bank’s underwriting for the first mortgage requires additional collateral. With fixed rates and a fully amortized term, overhead costs are stabilized and business owners can build equity.

Business owners can find out if they are eligible for the 7(a) and 504 programs by contacting their banker or their local Certified Development Company.

Barbara Morrison. CEO of TMC Financing, a Certified Development Company in San Francisco


Since the housing recovery began in mid-2009, the U.S. real estate market has seen a tremendous influx of capital invested from a variety of domestic and international investors. There is also greater demand for smaller deals, particularly in the commercial sector in secondary and tertiary markets, which the larger investment firms have been targeting. Over the past year (ending March 31, 2014), these smaller deals have experienced the most significant year-over-year price gain at 17.2 percent- the strongest since the recovery began, according to CoStar. This data strongly supports an increased appetite among larger investment firms for smaller deals in non-core markets. We have transacted several deals in Southern California with major investment firms that ranged from $5 million to $15 million over the past year. This is the first time we’ve seen such interest for non-core assets by more institutional-oriented investors. There is also an influx of private equity firms entering this market, which were not traditionally focused on real estate. Many private equity firms expressed some hesitancy in the equity markets and a belief that the stock market is due for a correction. They view real estate as a strategic hedge to their existing portfolio, as well as an opportunity to generate stable cash flow streams with strong upside in value appreciation.

Another trending topic in the real estate market is the strong interest from Asian investors on both the equity side and the debt side. Chinese investors in particular have been focusing on gateway and port cities like Los Angeles and San Francisco. Two different sites were recently acquired by Chinese developers to construct some of the biggest projects in Downtown Los Angeles. Shanghai Greenland Group purchased an entire city block with plans to develop 1.65million square feet of residential and commercial space. Oceanwide Real Estate Group purchased 4.6 acres and plans to develop a 1.5-million-squarefoot, mixed-use development.

On the debt side, a number of Asian banks have increased their lending activities throughout Southern California. Banks like Royal Business Bank and Evertrust have been making a large push to expand their presence and attract business from the Chinese American communities. Another interesting development is the consolidation among smaller banks, particularly in Southern California. Some notable acquisitions include: Banc of California acquiring Beach Business Bank and The Private Bank of California; Grandpoint Bank acquiring Gilmore Bank; and Royal Business Bank acquiring Los Angeles National Bank. While there are a number of reasons for consolidation, which range from branch expansion and improved balance sheets to expanded product offerings, we are seeing improved service and greater product availability on the lending side. We have traditionally found that banks tend to stick to one asset class and/ or product type, but as more and more banks consolidate, they are now willing to lend on a variety of deal types. For example, prior to the Grandpoint acquisition, Gilmore primarily focused on single-family residences. However, under the Grandpoint umbrella, it has expanded its product offering to include multifamily development. This type of expanded product offering has been quite common amongst these smaller banks. While increased demand from the investment community has helped drive strong gains in the marketplace, this has been forcing small investment shops and mom-and-pop investors to become more creative in the types of deals they pursue and how they source them. Mom-and-pop investors have traditionally sought simple deals that do not require an incredible amount of management to stabilize. As inventory wanes, however, they have been more willing to pursue projects that have complex elements involved. We recently sold an industrial building to a small family office that intends to reposition the building into a multi-tenant retail site. There are also many mom-and-pop investors acquiring office buildings and converting them into apartments. These types of projects are management- and capital intensive, which make them better suited for companies with the infrastructure and capital to execute. However, as the market becomes saturated with more investors, mom-and-pop investors will need to be willing to take on more complex deals. Another challenge facing small investment shops is access to deal flow. Competing against large institutions is a daunting task. Smaller firms need to constantly figure out how to source deals before the larger players see them. One way is searching for off market deals. More than 90 percent of the deals Ness acquired last year were off-market. This continues to be the primary way in which we, along with many other small investment shops, will be pursuing deals.

Daniel Mense, Director, Ness Holdings Inc. in Los Angeles


Loan maturities may be on the horizon, but the effects of these maturities are being felt by borrowers today. Refinance activity has gradually increased over the past year, and is expected to increase more rapidly over the next few years. According to the Mortgage Bankers Association, commercial and multifamily originations are expected to grow 7 percent year-over-year to $300 billion in 2014. They are then expected to continue their climb, reaching $333 billion by 2016. This substantial increase is a direct result of loans that were originated at the height of the market, just prior to the capital market upheaval.

At the peak of the commercial real estate market between 2005 and 2007, loan originations were at an all-time high based on ever-rising property values coupled with low interest rates and tremendous sales activity. Now, about 10 years later, a significant amount of these loans are approaching maturity. The sheer volume of loans approaching maturity over the next three years, along with the anticipation of rising interest rates, creates an environment of uncertainty. The potential the capital markets has of meeting the volume of expected maturities has owners and their mortgage bankers sizing their portfolios and discussing options available to them. While waiting to refinance at the time of loan maturity works for many owners, another option for borrowers to consider is a future funding commitment. Owners and investors are working with their mortgage bankers to analyze whether a future funding commitment is worth consideration. Through a future funding commitment, owners and investors can mitigate interest rate risk by locking in an interest rate now in anticipation of rates increasing in the future. Most life insurance companies are providing future funding commitments at a premium, ranging from three to four basis points per month, added to the base rate of the loan. These commitments can extend up to a maximum of 18 months. The future funding commitment allows owners and investors to have their properties appraised, interest rates locked in and, instead of funding within the next 30 to 45 days, the loan will fund at a future date coinciding with the actual maturity date. In doing so, owners and investors are able to eliminate some of the uncertainty of the future interest rate market.

It is difficult to predict what interest rates will be a year or two years from now, thanks to a constantly changing economic environment. However, with the outstanding commercial and multifamily mortgage debt expected to reach $2.6 trillion in 2014 (and $2.7 trillion by the end of 2016), borrowers should pay attention to this now. Today is the ideal time to consult with your mortgage banker to establish a forward-looking strategy.

Patrick Ward, Founder, MetroGroup Realty Finance in Newport Beach, Calif.


Commercial real estate lending is rapidly transforming. Changing capital stacks, shifts in investment activity, and a resurgence of development are reshaping the lending market.

Lenders Are Working Together

Borrowers are finding optimal lending solutions with lenders who partner with other lenders to provide higher leverage while maintaining a relatively low blended rate. The result is generally much better than a single lender could offer on its own. For example, Lone Oak Fund,-a fund with more than 700-highnet-worth members, recently partnered with two other lenders to provide financing for the acquisition of multiple investment properties in Newport Beach, Calif. The borrower was acquiring a pool of properties composed of a 16-room boutique hotel with ground-floor restaurant, a quadruplex and a beachside cottage, for a total of $7.14 million. The capital stack was made up of three separate sources, including:
• A first trust deed from Lone Oak Fund
• A second trust deed from a junior lender, sourced by Lone Oak Fund
• A third trust deed from a private equity investor

By working together, the three lenders were able to provide the borrower with leverage totaling 80 percent of the cost at a competitive blended rate below 10 percent. All three loans closed concurrently in less than two weeks. Combinations of this sort are becoming more frequent as lenders identify new ways to partner in order to help borrowers increase their purchasing power, while still maintaining competitive terms.

Investors Are Re-Focusing

As capital is more readily available and investors continue to seek new opportunities, a second trend that is emerging in the commercial lending market is a shift in investor activity. Many investors are beginning to seek properties outside of their initial investment plans, due to a lack of opportunities in the geographic or property type of their initial parameters. Investors are migrating to tertiary markets and different asset classes.

For example, one of Lone Oak Fund’s clients was focused only on multifamily properties in Sacramento since the market downturn in 2008. With the current lack of multifamily inventory, the client recognized a larger opportunity to invest in high-end homes in Southern California, and has transitioned to these investments. This shift is particularly prominent for multifamily investors. Multifamily has remained the preferred asset class among domestic and international investors, and with too many dollars chasing a decreasing number of opportunities, today’s commercial investors are now looking at hotels, high-end homes, and traditional commercial properties as better potential avenues for investment. This trend is driven by domestic and foreign investors’ search for yield. Foreign capital has poured into the U.S. real estate market, primarily in gateway cities, increasing competition and decreasing the supply of opportunities. The demand has compressed cap rates in primary markets, forcing investors to search out other opportunities for desired returns.

Development Financing Is Back

Finally, as feasible commercial real estate development opportunities return, lending on these projects is beginning to surge as well. In fact, lending has become available not only for redevelopment, but also for ground-up construction and land. For example, Lone Oak recently funded an acquisition loan on entitled land for an experienced Bay Area developer. The developer acquired an 11,737-square-foot lot with plans to build a 30,000-square-foot, mixed-use property at the site. Investors are actively redeveloping properties as well. Lone Oak recently provided a loan for the redevelopment of an industrial property in Downtown Los Angeles, which will be converted into a creative office space. As owners continue to reposition their properties, developers identify opportunities for new developments, and investors seek out new geographies and new product types, commercial lending will continue to increase.

Alexa Mizrahi, Loan Officer. Lone Oak Fund LLC in Los Angeles

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