How Lenders Are Searching For Pearls In Real Estate’s Choppy Seas

The cranes that dot Miami's skyline are in some ways a relic of a different market, when debt was cheap and stimulus checks came in the mail.

It's a lot harder to get a crane in the sky today, but lenders and developers are engaged in a dance to find the sweet spot where projects make financial sense and investors make money.

“It's a safer moment to be lending than two years ago when there was too much competition,” Linkvest Capital CEO Camilo Niño said at Bisnow’s South Florida Capital Markets and CRE Finance event Tuesday. “The problem is that raising capital from individual investors is getting much more difficult.” 

The rapid rise in interest rates created a paradigm shift in capital markets just after the pandemic supercharged development interest in Miami.

Developers are finding cash in creative places to make deals work, but lenders are responding cautiously, carefully vetting deals to avoid risk. Paul Cleary, chief operating officer at North Carolina-based Red Oak Capital Holdings, said many looking to build in Miami offer overly rosy projections, considering the market's stagnant rents and heavy competition.

“Some of the pro formas we see here are insane,” Cleary said. “You're not going to get a deal done when you haven't taken a good dose of reality.”

Developers are trying to meet the lofty expectations of investors who became accustomed to outsized returns on real estate during the recent period of record-low interest rates, speakers said from the stage Tuesday at the Loews Hotel in the Plaza Coral Gables.

Investors are being asked to accept less of a return on a real estate deal when the yield on Treasury bonds hovers around 5%.

“If you can make 5% doing absolutely nothing in a money market account right now, that sounds pretty good,” said Jacques Holzmann, managing director at alternative investor Kawa. “You’re not going to go out there and do some risky deal.”

Traditional banks have also pulled back from real estate lending as they face pressure from regulators to shore up balance sheets as property values fall on assets they’ve backed. Private equity, debt funds and other capital is filling that gap at a smaller lending volume, giving them pricing power over loan terms and further driving up the cost of debt. 

Well-funded sponsors have been able to make deals by injecting equity to reduce their leverage and the lender's risk, but smaller players have had to build a more diverse capital stack at a property to get it out of the ground or refinanced.

Developers are once again leaning on the EB-5 Immigrant Investor Program, which trades a U.S. visa for investment in real estate or other job-creating enterprises in the country, to raise capital after a couple of years of waning interest in the program, Niño said. 

Insurance waivers that allow debt to be carried on a property that doesn’t have coverage up to full replacement cost are also becoming more common as a way to control costs, said Marty McGrogan, a senior mortgage banker at KeyBank.

Lenders have some flexibility, Niño said, but they ultimately favor deals with fewer points of exposure. 

“We don’t like when developers use too much creativity, because being creative can be risky,” he said. “If the deal doesn’t work with the current market conditions, you either need to add value to make it work or you have to wait.”

Property owners with loans coming due may not have the option to wait, although panelists said banks had been broadly open to extending loan terms and payment structures on maturing debt as sponsors wait for the market to improve. 

Debate rages over whether valuations have bottomed out and if the pace of transactions will pick up, but panelists stressed that the single forecast 25-basis-point rate cut in September will do little to alleviate pressure on the commercial real estate sector. 

“We love stories of hope, but I can think of a few deals that I just wanted to tell the sponsor to sell,” Holzmann said. 

Kawa will still provide the bridge financing that those sponsors are seeking in many cases, confident that the landlord will be able to make payments. But Holzmann worries those customers are overly optimistic that rate cuts are coming anytime soon.

“You’re really just hoping for the future and not solving for today,” he said. 

Investors looking to deploy capital in real estate have increasingly turned to “stranger and stranger transactions” to find higher returns, Dansker Capital Group CEO Andrew Dansker said. His firm is conducting due diligence to finance its first nudist colony.

“We hadn't seen that before, hope to never see that again,” Dansker said. “It's an interesting asset class. Very high cap rates, limited buyer pool.”

Sun Belt markets, particularly South Florida, continue to be the popular destinations for investors, McGrogan said. But longtime Miami developers and lenders said they have concerns that public and private infrastructure hasn’t kept up with the pace of new development. 

Robbie Pinkas, senior vice president at Pace Loan Group, said that his energy-efficiency-focused lending business gives him exposure to a broad range of projects across the country. In other fast-growing markets, infrastructure investments are being made to support the growing population.

“I'm not seeing any of those here,” he said. “That is my single greatest concern about the ultimate resiliency of this market. We don't have the infrastructure necessary to accommodate this growth. That's fine for now, but at a certain point, it won't be.” 

Business and community leaders have long been saying the lack of affordable housing could hinder growth in the region, and access to schools has become a pressing concern that has kept some executives from relocating. 

But the city’s gridlocked streets, limited garbage capacity and overflowing sewage systems present critical near-term challenges that local governments will have to address.  

But the same developers and lenders nervously eyeing the immediate infrastructure problems facing South Florida are less concerned about the long-term threats presented by climate change.  

“It’s a tomorrow problem for a lot of people,” said Frank Guerra, founder of the development firm Altis Cardinal and moderator of both panels. “We’re making loans today.”