FEATURE ARTICLE, SEPTEMBER 2008

THE SKY IS FALLING, THE SKY IS FALLING! OR IS IT?
Just how bad is the lending environment?
Interview by Stephanie Mayhew

Palmier

Everyone will agree that the financial climate has seen better days, but just how bad is it, and what can we expect in the coming months? We sat down with Daniel M. Palmier (DP), the founder, president, and CEO of Potomac Realty Capital, to find out some answers. With more than 25 years of experience in the real estate and financing business, Palmier has seen his share of ups and downs, and this is what he had to say about the current cycle.

NREB: Can you characterize the current lending environment in the Northeast?

DP: I think it is as bad as I have seen it in my 25-plus year career. The CMBS market, for all intents and purposes, has shut down. Banks that are in the market to lend are lending at 20 percent to 25 percent less leverage than they were 12 to 18 months ago. The situation is the same for the life companies. The rest of the market is just not there, especially the specialty finance/CDO lenders, which are licking their wounds, so to speak, dealing with their own financial problems, and are not thinking about lending. I am pleased to report that as a direct balance sheet lender, things at Potomac haven’t changed since day one.

NREB: When do you see the lending climate turning around for the better?

DP: My instinct is that the market is going to get worse over the next 6 to 9 months, which would put us into the first/second quarter of 2009, before we start to see a light at the end of the tunnel.

NREB: What kind of lending activity are you still seeing?

DP: Based on the phone calls that we are getting here at Potomac, I don’t know of too many groups that are out there lending. A handful of banks and life companies are still lending, and Fannie Mae and Freddie Mac are definitely lending on the multifamily side. There are smatterings of private equity and opportunity funds that are mobilizing to take advantage of distressed deal and “paper” opportunities in the marketplace. They are raising capital, but these are not lenders, they are more of a hedge fund/entrepreneurial equity type of play. These funds are really mobilizing as a way to take advantage of distressed opportunities in the marketplace, whether it be buying financial instruments from Wall Street or just trying to take advantage of highly distressed situations.

NREB: Are there certain property types that lenders are more willing to lend on than others?

DP: The market has returned to a traditional way of lending with a focus on 3 of the 4 food groups — multifamily, office and industrial. The hospitality sector has fallen out of favor with lenders, as has land. Anything that has an entrepreneurial story is really going to be out of favor today with lenders. Lenders have also become weary in regards to lending on retail projects. Retail was a sector that was over-financed, and it is also a sector that is closely tied to the economy. With the current economic climate, the downturn in consumer confidence, declining job growth, and too much gross leasable space in the marketplace, it is really a bad environment for the retail sector.

NREB: Is any particular market hot right now? Are there markets that banks might be more willing to lend in than others?

DP: I would not call any market hot right now, but there are still some safe markets that lenders are working in. New York City was probably the last hot market. It is still a good market, but it is certainly not as hot as it was the last couple of years. Obviously with the financial woes of Wall Street and the financial services sector being so off, there are a lot of layoffs, and that is starting to impact the real estate market there. We have financed six deals in the last 6 weeks: five multifamily and one retail in San Antonio, New York City, Upstate New York, North Carolina and Maryland.

NREB: What types of loans are more popular right now?

DP: On the multifamily side of the equation, we are originating several permanent loans and placing multiple deals with Fannie Mae and Freddie Mac. Because of the CMBS market being virtually shut down, we are doing a lot of refinances of our competitor’s loans, as well as our own on a floating rate basis, so that they can seek a permanent loan sometime in the future when the market starts to recover.

NREB: How has the current climate affected commercial real estate investing? 

DP: The volume of deals are a mere fraction of what they were prior to 2008. Many investors are looking for bargains and distressed deals, but overall, there are not many trades happening. Sellers are holding tight and buyers that have capital are searching very diligently. I think the current market can be described as disengaged. Both sellers and buyers are disengaged. Sellers are holding on to their properties, and my viewpoint is that sellers will start to acquiesce or capitulate to the falling value of their real estate the longer this cycle continues.

NREB: Have people also backed away from developing because of the current market?

DP: Yes, and a major part of that is the lack of capital for development opportunities. Housing is down, retail is being squeezed, and many developers are dealing with existing financial woes and lenders that are looking to de-lever existing loans, i.e., making margin capital calls on them.

NREB: How has the recent news on Fannie Mae and Freddie Mac impacted the market?

DP: It has become more of a “chicken little” type scenario, which we have been going through for some time. In the last year, the commercial sector has been negatively impacted by the financial problems caused by sub-prime fallout. This factor, coupled with the fact that the GSE’s are now under scrutiny has added even more negativity to the current situation. From a commercial standpoint, I am not seeing any impact on Fannie or Freddie’s business plan or what they are willing to finance or not finance, but they are certainly a little more conservative, but that is because they can be. There is very little competition for long-term, fixed rate permanent financing out there.

NREB: How has the Fed’s recent gloomy report to Congress affected the current lending environment?

DP: Most of the psychological damage has already been done. Very sophisticated business people populate the commercial side of the equation, so I don’t see the media dramatically impacting the commercial market. The press and the Fed are reporting on data that we all have been experiencing for some time. I think it is more of the same story with the negativity. The Fed’s report may have pushed out people’s horizon as far as when they think the recovery of the market will happen, but not really the temperature of how bad it is.

NREB: How can owners, developers, investors, etc. in the commercial real estate industry deal with some of the current lending woes?

DP: Pray a lot. Just kidding. Capital and time are the name of the game now. By and large, we are telling our clients that it is better to hold on, because it is not the best time to seek a permanent loan, even though we provide that product line, as well. We think that a floating rate, short-term bridge loan is the best way to finance a property through this cycle. A company needs to do what they do best, and if they are a management company, that means continuing to roll up their sleeves and aggressively manage their properties, and enhance the bottom line of their properties the best they can. I remember doing workouts for one of the top investment banks on Wall Street back in the early 1990s. The mantra back then was, “Stay alive til’ 1995.” Today maybe the mantra should be “It will be good again by the end of 2010.”  Things will get better, because we have seen this cycle before, and although it may get a little worse, the market will recover.

NREB: Are there any other lending issues or  trends you would like to discuss?

DP: Right now, we are spending much of our time on bringing in new capital of both debt and equity. Because of the growing niche and growing pipeline that we have, we are very bullish on providing financing and it is a great time for us. It is a great time to be an entrepreneurial balance sheet lender.

Daniel M. Palmier is the founder, president, and CEO of Potomac Realty Capital, a specialty real estate finance company focused on structured financial solutions and permanent real estate loans for all commercial property types. 

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