lending advice

by Mark Levine

If you listen closely, you can hear a crunching noise. Actually, you don’t really have to listen closely at all. The sounds of the current “credit crunch” are often so loud that they’re probably even waking you up from an otherwise peaceful slumber on some occasions. Personally, I haven’t slept well since about March; that’s when my local newspaper had to define the word “subprime” as if it were a foreign term. Now the newspaper seems to mention it on a daily basis on every page outside of the “Sports” section.

The crunch is upon us and in full swing. For regular readers of this column, you know the general reasons for the troubled state of the mortgage market, and you know the implications for apartment investors. Undoubtedly, you have also read countless articles or watched many interviews about what happened and who’s to blame. Because the news is so widespread, and because it still seems to be evolving on a daily basis, we won’t retell the story here.

There are two questions, however, which deserve some additional attention. The first is, how long will the credit crunch last? Maybe the revised mortgage parameters that we are facing today will form the new base standards of tomorrow. If that’s the case, this isn’t really a crunch at all; it’s just an adjustment back to tighter standards, which will remain in place. Many pundits have recently called this a “repricing of risk.”

However, I do not think that this is the case. Markets are too dynamic and competition is too fierce for the system to suddenly retreat for good. As long as people and companies are making money, someone will continue to push the limits to some degree. Certainly, the limits will not move nearly as fast or as far as they have in the past. Those who have some appetite for risk will cautiously dip their toes back into dangerous waters. To be sure, however, nobody will jump back into the pool head first with blindfolds on, as they had been doing in the recent past.

On this note, many people have asked why the credit markets and lenders haven’t already begun to turn around. Remarkably, our most recent example with which to compare the current climate is the 1998 credit crisis triggered by the Asian and Russian financial crises. Domestic market conditions turned around in impressively quick fashion back then. In fact, in hindsight, the 1998 hiccup in the market is now viewed as exactly that: a mere hiccup. So far, we haven’t been that fortunate this time around. If my assumptions are correct, this situation will be viewed as more than just a quick disruption when we look back in 10 years.

However, as I stated, conditions will eventually improve and borrowers will again enjoy reasonably easy access to debt. This will likely come at some point in the middle of 2008. As simple as this may sound, the first hurdle to clear is the flip of the calendar past 2007. We can run thousands of computer models and talk to hundreds of seasoned analysts to discover the technical issues at hand. But, to some degree, a psychiatrist is better equipped to explain the fact that there are still very significant psychological influences that affect our markets and financial behavior. To this end, I believe that we need to put the year 2007 behind us before we can really begin to look forward to market improvements.

Of course, there are also some technical issues that coincide with flipping the calendar to a new year. One of the more obvious issues is the reporting of year-end results. With this event comes the need to mark loans and other assets to market prices, and thus the need for everyone to disclose what they really hold.

Many entities have gone through this painful process already, either because they felt it prudent, or because they were obligated by covenants attached to loans and other financial obligations. The results have not been pleasant, but the expectations have been well managed and the casualties relatively limited. By the end of the year, however, nearly everyone will have gone through this process and the overall results might not be as good.

Another tangible issue that comes along with the new year is overall corporate strategy planning for the future. This could include anything from cutting the technology budget to a decision to leave the real-estate lending arena altogether. It likely will mean lower bonus payments for the bankers who share in internal profits, and job layoffs for those who are even less fortunate. For lenders who stay in the business, there will be bigger commitments to both credit professionals and credit hedging strategies. In sum, the turn of the calendar is a time for everyone to get their financial houses in order.

This is a good thing. Market turmoil cleans out the folks who were not committed to the business and only entered it because they saw easy money. In effect, it identifies the serious players who have made a long-term commitment to the business and who will continue to build it. Conditions will begin to change for the better only after these serious lenders have been identified, gotten their respective houses in order and stated a firm ongoing commitment to the business.

They will put the layoffs, financial losses and reputational damage behind them, and they will again look ahead to making prudent, yet pro-business decisions.
Now that we have discussed how long the credit crunch will last, it’s time to ask the second question: what can you do to weather the storm? Some would say that you should stop investing in real estate and wait until the markets stabilize. Others would say that you shouldn’t consider even refinancing a property in this market—at least until interest rates stop fluctuating so dramatically. There are even those doomsday prognosticators who are hording as much cash as possible and stashing it under the mattress. Then there are always the contrarians, aggressively looking for a bargain in what they think is an oversold market. They are purchasing subprime loan pools from distressed lenders, seeking houses that have been foreclosed upon and taking big bets against some of the residential lenders who are still standing.

The answer, which might seem obvious, is to find your place in the middle. Don’t disrupt your normal business operations and strategies because the debt markets have changed recently. You can’t control the broad movements of the market, and you shouldn’t let them control you. But also, don’t assume that everyone else is panicking too much and that therefore you can take advantage of the situation. The credit crunch is real and the fundamentals of the market are truly affected, so it would be naïve to think that you can outsmart the reality of the situation.

Those are some suggestions of what not to do. So, what can you do to manage success in the market? The answer, in my opinion, is to do nothing. That is to say, do nothing differently than you have been doing in the past. If you have been in a buying mode, and you want to increase the size of your real-estate portfolio, you should be shopping for deals. If you have been in a selling mode recently in order to fund your pending retirement years, market your properties aggressively and stick with your plans. If you regularly watch interest rates in order to find a good time to refinance your high-rate mortgages, now is the time to jump on some great opportunities.

There is a flaw with this strategy, however. If credit standards have significantly tightened and many lenders have already exited the business, there is less debt available. So if everyone proceeds under my advice to conduct business as usual, there will be the same amount of loan demand chasing a greatly limited loan supply. How do you ensure that you get your fair share of available mortgage proceeds when suddenly you are competing with others for a more finite and selective supply?

This is where you should review your strategy and make adjustments if necessary. In the past, borrowers were able to send out any information remotely related to a property and quickly receive aggressive term sheets from multiple lenders. I equate this to throwing a bare hook into the water and getting five bites immediately from extremely hungry fish. Today, the fish are not as hungry and there are fewer of them. Therefore, you need to dress that hook with some rather appetizing bait in order to get some attention. In other words, make your next loan request very appealing to lenders.

The bare minimum amount of information to be included in a good financing request should include a few essential items. Start with a rent roll, at least a full year of detailed operating statements and a good physical property description. Pictures are also very important since, in our business, they really do speak a thousand words. Also, detail your actual request. It sounds obvious, but you would be surprised by how many loan requests do not actually state what the borrower wants. Clearly, the lender should be creative and smart in determining an appropriate loan structure, but it will benefit you to list the expected loan amount, term, rate structure and any other particular sensitivities.

Lastly, if your lender does not know your personal background, a good resume or borrower summary is also essential. This should include liquidity and net worth estimates, a list of owned and managed real estate, and a brief summary of applicable experience. One of the biggest credit adjustments in this changed market is a renewed focus on sponsorship history and experience, so you will save time by providing this information at the outset. Even with nonrecourse loans, this is still a people business, so you will help yourself by informing creditors of the reasons why they should lend money to you.

If you include these basic criteria, your loan request will stand out above others and you will find that there are still good loan terms available to you. Regardless of how long this credit adjustment lasts, you will successfully weather the storm and hopefully sleep well all the way through the crunch.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or SF Apartment Magazine. Mark Levine is a vice president in the San Francisco office of ARCS Commercial Mortgage. He can be reached at 415-981-9700 or Mark_Levine@arcscommercial.com. Copyright © 2007 by SF Apartment Magazine. All rights reserved.