Wall Street banks, stung by worsening market conditions, are not only unloading their commercial real estate holdings, they’ll help buyers purchase them as well. They and other financial institutions are increasingly resorting to seller financing to help realign their bloated balance sheets. This activity has intensified as market volatility has all but shut off conventional sources of credit.
Seller financing was virtually nonexistent before the credit crunch, when funds from banks and specialty lenders were plentiful. But as lenders have cut back, sellers have stepped up. On $85 billion in commercial real estate sales of at least $5 million in the first half of 2008, seller financing amounted to $3.4 billion, according to New York–based Real Capital Analytics. There was virtually no such activity a year earlier, and “it’s a trend that’s really starting to steamroll,” says Andrew Stark, executive managing director of New York–based Cantor Real Estate, an investment arm of securities firm Cantor Fitzgerald. The market sorely needs seller financing, he adds, because “without it we’re going to be frozen.”
In one recent example, San Francisco–based Shorenstein Properties, which buys and operates office buildings, obtained seller financing on two Manhattan buildings it purchased from Deutsche Bank. The bank felt a sense of urgency to sell when the original owner, New York’s Macklowe Properties, defaulted. The sale price was $930 million, and Deutsche offered $511 million, or 55 percent, in seller financing.
Sellers will typically finance up to a maximum of 75 percent of the purchase price, over a one- to five-year term. “Seller-finance providers excel at finding terms that you can’t find in the market,” says Brian Stoffers, president of Houston-based CB Richard Ellis Capital Markets. Pricing is generally on par with, or cheaper than, that of third-party lenders, within a range of 350 to 400 basis points over Treasuries.
These loans work for both sides. Buyers get attractive terms, and sellers help prop up the market by fostering deal flow. But as in any lending situation, a seller-financer bears the risk of default. As a result, sellers must keep a close eye on borrowers’ credentials and on their own equity stakes in the properties. Because the financing is structured as a credit against the purchase price of an asset, it registers as a loan on the sellers’ books.
“That financing is term financing, and it stays on your balance sheet,” says Robert Brennan, global head of real estate finance and securitization at Credit Suisse in New York. “You’ve just changed the risk composition of your portfolio.”
With that in mind sellers generally do not engage in self-financing lightly. When they do, it can be a sign that they are under pressure to sell. Most owners therefore “take a wait-and-see attitude” before deciding to finance their sales, says Daniel Lisser, a managing director at Irvine, California–based real estate investment banking firm Johnson Capital.
Owners also may consider financing to be a natural extension of their business. “Many of the institutions that own properties are both investors and lenders. Therefore for them to structure and take on financing risk isn’t a big leap,” notes Douglas Hercher, managing director and principal at New York–based real estate investment banking firm Cushman & Wakefield Sonnenblick Goldman.
Jon Vaccaro, global head of commercial real estate at Deutsche Bank, says, “It makes a lot more sense for a bank to move its risk from running and operating a property to owning a piece of debt.” He contends that seller financing, as in the case of the Macklowe properties, can be a win for all sides. “The buyer is looking at it as an opportunity, and the seller is looking at it as de-risking the balance sheet.” He adds that Deutsche plans to syndicate — sell in pieces to other banks — its $511 million loan.
“Any financing that can help a buyer bridge this difficult debt environment for quality real estate is a huge plus,” says Mark McCarthy, a managing director in the capital transactions group at Shorenstein.
Market participants are also looking to the U.S. Treasury’s rescue plan to increase liquidity and reduce the need for seller financing. “LIBOR is drifting downward, and the commercial paper market has eased up,” observes CB Richard Ellis’s Stoffers. But it hasn’t yet lessened the need for financing alternatives.
