Cantor Lends $270 Million Against NYC’s 26 Broadway

Cantor Commercial Real Estate Lending has provided $270 million of senior and mezzanine financing against 26 Broadway, a 900,000-square-foot office property in Manhattan’s Financial District.

 

The seven-year financing includes a senior loan, with a balance of $220 million, that is expected to be securitized.

 

The 32-story property, also known as the Standard Oil Building, is owned by the Chetrit Group, which in 2007 acquired it, along with three of the four land parcels on which it sits, from the Koeppel family for $225 million. Five years ago, it paid $35 million for the last land parcel.

 

The property previously was encumbered by a $183.5 million loan that Wells Fargo Bank acquired last year from a collateralized debt obligation that was managed by what’s now Gramercy Property Trust.

 

The 26 Broadway building is 90 percent occupied, which is up from 76 percent last year, thanks to some 126,000 sf of new leases that were signed in recent months. Those include a 45,000 sf agreement with the New York Film Academy, which will occupy its space through 2029, and 20,000 sf agreements with graphic-design company Ustwo Studio Inc. and law firm Schlam Stone & Dolan.

Its largest tenant is the New York City Department of Education, in 181,659 sf through January 2039 on behalf of the Lower Manhattan Community Middle School.

 

New York City has designated the 26 Broadway building as a landmark. It was constructed in 1928 by Standard Oil Co., which used it as its headquarters until 1956, when it moved to 150 East 42nd St.

The building includes 3,500 sf of retail space.

Preferred Equity vs. Mezzanine Debt

An investor seeking a higher return than that available to a mezzanine lender, and not unduly concerned about exit strategies, can negotiate a senior equity position as a “preferred equity” holder. Preferred equity is most often used when a property is generating insufficient cash flow to service a junior or mezzanine loan, or where the senior lender prohibits subordinate financing. In some cases, a mezzanine lender may choose preferred equity because a debt position could have adverse tax consequences or in some way does not qualify under the lender's investment rules.

Enhanced Rights

While preferred equity clearly is subordinate to all debt, it does have some priority rights over other equity owners. The most important of these is the right to receive a preferred distribution, typically in the range of 12 to18 percent, on the invested amount. The actual rate will depend on a variety of factors. In addition, the preferred equity investor usually has the right to approve all major decisions of the general partner or managing member. Under certain circumstances, the preferred equity holder may become the general partner or managing member.

While the preferred equity holder has priority over other equity holders with respect to distributions, there is no assurance when payments will be made or indeed, if they ever will be made in the event the project fails. Finally, the preferred equity investment often has no maturity date.

Total Return

As noted above, the preferred equity has first claim on equity distributions equal to a designated percentage of its investment. In addition, the preferred equity will share in the capital appreciation of the venture. As a result, the preferred equity holder may receive a higher return than a mezzanine lender whose return is capped. The net effect is to raise the overall cost of capital to the common equity holders as compared to using mezzanine loans, but the benefit is that the carrying costs of the property are reduced.

Using Hurdle Levels

Preferred equity often is used in connection with new developments. Once the parties have agreed as to the amount, timing and form of the equity to be provided, they must agree about the division of returns to the developer and the equity party. The objective is to minimize the downside risk to the equity investor while providing a substantial incentive to the developer partner for the deal to perform in excess of expectations. This usually is accomplished by staging the returns to each party through so-called “hurdle” levels.

Example: Assume the equity partner puts up 90 percent and the developer puts up 10 percent. The initial split might be pari passu, until each party receives 12 to 15 percent of their investment. Additional cash flow would be distributed 80-20 between investor and developer until the investor has achieved a stipulated internal rate of return (say, 15 to 20 percent). Any additional cash flow would be split 60-70 percent to the investor and 40-30 percent to the developer. Since a construction project on an all-cash basis may return only 10 to 11 percent, the returns just described can be achieved only because of the upside leverage provided by the construction loan. A construction loan equal to 75 percent of cost at an interest rate of 8.5 percent increases the overall return to the 15 to 20 percent range.

Cashing Out

An important aspect to be negotiated between the developer and the equity investor is if and when the latter can exit from the investment. Under normal circumstances, the maximum value of the project is achieved only after the project is fully constructed and has been operating long enough to establish a stabilized net income. At that point, the construction lender will be taken out by a permanent loan, but any excess permanent loan proceeds are not likely to be sufficient to pay off the equity investor.

In devising an exit strategy during the initial negotiations, the developer and the equity partner can consider several alternatives. For example, the developer may be willing to sell the project. If the developer is not a merchant builder but wishes to hold the property in a portfolio, the developer may agree to take out a second mortgage or find a new equity partner.

Bridging the financing gap: New funds could inject $220M to spur commercial development

Summary: Foreclosure- and repossession-ridden Michigan has been left with little access to liquidity from banks and investors.  In response, the Michigan State Housing Development Authority (MSHDA) is launching a $100 million mezzanine fund for multi-family, mixed-used and residential projects throughout the state.  Similarly, Great Lakes Capital Fund is working toward a $120 million fund allocated to underwriting loans to Michigan developers.  Meanwhile, regional banks have used the real estate rebound to clear foreclosed and repossessed houses from their balance sheets.  Developers and entrepreneurs are hoping that these funds will help with second tier funding to close the gap between <60% LTV and equity investors who are looking for more leverage.

Grand Rapids --(MiBiz)--
Commercial real estate developers in West Michigan could soon get some much needed relief from their struggles to access bank financing.

Still smarting from the millions in losses they incurred from foreclosed and repossessed properties, banks are keeping the purse strings tight on loans for commercial real estate projects. That has developers facing a financing gap in the market as the economy improves.

“There is a (financing) gap out there,” said Michael Price, chief executive officer of Grand Rapids-based Mercantile Bank Corp. “There are lots of good ideas that have come not only in the real estate market, but in manufacturing and other commercial opportunities where there just needs to be that level of debt that has a bit of higher risk profile than what a traditional bank financing package looks like.”

With developers and banks finding it difficult to work the numbers on many potential projects, that’s left some in development limbo, Price said.

There may be some help on the horizon. Two new funds expected to hit Michigan markets next year with up to $220 million in project financing could help close the financing gap.

The Michigan State Housing Development Authority (MSHDA) announced on Sept. 25 that it is launching a possible $100 million mezzanine fund with a focus on providing financing to urban multi-family, mixed-used residential projects across the state.

Also in September, MiBiz reported Lansing-based Great Lakes Capital Fund, via its Develop Michigan Inc. economic development arm, is working to close a $120 million offering for its Develop Michigan Real Estate Fund LP. Company officials say they plan to use the fund to provide capital for a program that would offer loans to commercial developers across the state.

It’s often the case that developers and entrepreneurs just don’t have access to the necessary equity that would make banks comfortable in extending the financing needed to push a project forward, Price said. Banks also just went through an intense period of trying to shed foreclosed assets from their balance sheets and salvage the losses from collapsed deals. In essence, they’re not in any hurry to risk adding more bad debt, he said.

Developers say they can typically get a bank loan for 50 percent to 60 percent of the total cost of a deal, but while they’re willing to put some equity into the projects, they’re still often left with a 30-percent funding gap. That’s created a need for a funding source that’s willing to come in and be last piece of capital that fits between senior debt and equity so that deals can move forward, said Chris LaGrand, chief housing investment officer at MSHDA.

With the availability of these funds, owners and developers have more financing options in structuring a difficult deal and more investors would have reason to invest in Michigan, LaGrand said.

Kalamazoo-based developer Tom Huff, owner of Peregrine Realty LLC, said the new funds could help fill a lending gap that’s been making it difficult to finance projects.

“It seems like these are great ideas that just open more options for developers,” Huff said. “Right now, the banks are timid and the appraisal market is also timid, so (these funds) make some sense.”

It’s no surprise that banks tightened their underwriting standards for property developments after the recession.

Local banks accumulated millions in foreclosed and repossessed real estate on their books in the recession. Deals with just one Holland-based developer, Scott Bosgraaf, left banks holding roughly $24 million in unpaid real estate loans and bad debt.

But Dan Yeomans, whose turnaround firm has been involved in the sale of $12.6 million of those foreclosed assets, doesn’t think developers should bear all the blame for the banks’ losses. Bad lending practices were often just as much to blame as over-extended developers, he said.

“I don’t even know how some of those loans were given,” said Yeomans, president of Amicus Management.

As the economy has improved, banks have gotten rid of foreclosed or repossessed properties, what’s known as “other real estate owned” or OREO. Locally, Mercantile Bank Corp., Macatawa Bank Corp. and Independent Bank Corp. combined have cleared their balance sheets of $17.1 million in OREO between Dec. 31, 2012 and June 30 of this year.

But because banks are reluctant to lend even as the economy has picked up, developers can’t assemble enough project financing to be able to meet the demands of the market. That’s where the new mezzanine financing could help, even if it’s at a higher interest rate and adds complexity to the deals, sources said.

While the new funds could make deals more complex in terms of layering different financing mechanisms and necessary paperwork, Price said the extra due diligence is worth it for a good project.

“In working a little with these types of funds and entities, they’ve made it fairly easy to work with, but of course, that’s always in eye of the beholder,” he said. “I’m not going to sugarcoat it, but every time you have another entity involved, that always includes another layer of paperwork and additional triggers and holds that need to be put in place. But all things considered, we think it’s eminently worth it for the entrepreneur or project team to spend the time.”

The process shouldn’t be so onerous that project managers will have to go out and hire a tremendous legal team to tackle the work, he said.

In the current market, many projects rely on the ability to secure building incentives primarily from state and local governments. At the same time, some incentives such as Renaissance Zones are retiring. Other incentives like the Michigan Economic Development Corp.’s Community Revitalization Program can help deals get off the ground, but the funds are always distributed on the back end of a deal when the project is complete.

Huff said his experience is that banks are reluctant to loan any more than 70 percent loan to value for projects despite the demand for urban residential development in many communities across the state. Those communities “need this kind of injection,” he said.

“This kind of keeps the momentum going,” Huff said. “There is definitely risk involved, but there is demand.”

Working in partnership with banks, MSHDA wants to identify a pipeline of deals that could unlock with the help of mezzanine debt, LaGrand said.

Given MSHDA’s strong portfolio of past successful projects, LaGrand believes the organization can convince investors to get involved in the Michigan market.

“We believe we have the history and market intelligence of doing deals in the state since 1960 that investors will find useful and attractive,” he said. “We’re thinking that we can offer investors an 8- to 10-percent yield, and the cost of the funds is around 14, 15, 16 percent. We think deals would pencil at those numbers.”

Right now, mezzanine debt is offered at around a 25-percent interest rate in some markets, which LaGrand said is a “go-away price.” Investors know deals don’t pencil at that rate, but initial conversations with investors have been positive, LaGrand said, noting the experience and market knowledge MSHDA can bring to the table.

The mezzanine fund is seeded with $25 million of non-taxpayer MSHDA reserve funds.

“We obviously believe this fund is going to provide a good return, which is why we’re moving the money,” LaGrand said. “We’re probably looking at the middle of next year for the first closing.”

The fund’s target investment is mixed-used multifamily housing in urban cores, the cost of which can range widely. LaGrand hopes to unlock primarily large-scale multi-million dollar developments. One stipulation to access the financing: Projects must have at least 50 percent of their units set at market-rate values.

“We want to get as many strong deals into the pipeline as possible,” he said. “Ideally, we want to be 10 to 30 percent of the investment cost of the deal. So if our target investment might be $10 to $20 million — depending on what percentage of the deal we are — you’re talking a $50 million real estate investment. That’s sort of the base level, and we can go higher.”

Given the potential returns for investors and MSHDA’s track record, Price of Mercantile Bank said he thinks the fund makes sense. He expects investors are really going to kick the tires on projects because of it.

“It all depends on the risk profile of projects,” he said. “(Investors) are clearly going to demand a higher return, but they are going to fill that gap that we think is going to allow some ideas and projects to go that may not have come to fruition — and hopefully provide a lot of job growth.”

http://mibiz.com/news/real-estate/item/20998-bridging-the-financing-gap-new-funds-could-inject-