by Todd McNeill

In the last 24 months the REIT’s have been busy adjusting their portfolios.  During the depths of the recession, REIT’s had access to low-cost debt and did not waste time locking in cheap capital by issuing record amounts of bond offerings.  With investors hungry for yield, REIT debt looked attractive, and the numbers were staggering in the amount of bonds that were issued.  Additionally, there have been some big REIT mergers, most notably KITE Realty Group merging with Inland Diversified Real Estate Trust.  The merger created a 20mm s.f. retail REIT with 130 shopping centers across 26 states and a market capitalization of $2.1 billion!

reits on the riseThe infusions of new cash, mergers, and lack of construction from 2009 through 2011 have caused REIT’s to shuffle their portfolios.  With new cash and excess properties, REIT’s are deploying the cash in new Class A assets that offer strong cash flows with stable rent rolls.  Meanwhile, REIT’s are selling the older properties in their portfolio that are in need of capital infusions to address deferred maintenance and/or stabilize deteriorating rent rolls.   During the recession, there was not much construction going on, and it allowed for current REIT portfolios to age and for lease terms to dwindle.  In some cases, like the Kite/Inland merger, some properties were disposed of as a result of concentration in the same submarkets.

All this activity has allowed entrepreneurs to swoop in and pick up retail, office, industrial, and multi-family assets in need of fresh ideas, capital upgrades, and leasing activity.  In the last 18 months Metropolitan Capital has been approached by numerous clients who have secured contracts on properties that have upcoming rollover issues and/or vacancy issues that can only be solved with hefty capital infusions and renewed leasing efforts.   In one case an MCA client acquired a property that was 60% leased from a very well-known retail REIT.  The REIT had acquired the property in 2006 at the height of the market and paid handsomely for the income stream.  The recession battered the rent roll, and the tenants that survived burned term off the leases, causing upcoming tenant rollover issues.  Rather than continue to pour money into the investment and increase the property basis, it was a better solution for the REIT to sell the asset, recoup their investment, and then redeploy the proceeds to upgrade their portfolio.  This situation created a great opportunity for an entrepreneurial retail firm to get the property at a great basis and create value in the leaseup.

With the recent turnaround in development activity, it is highly likely that REIT’s will continue to divest of lower-quality assets and reposition their portfolios to purchase the new class A assets with strong cash flows and stable rent rolls.  This will create opportunities for highly skilled entrepreneurial property buyers to acquire “value add” properties.

It is not surprising that with the abundance of capital in the market, one of the most attractive financing options is reasonably priced bridge debt.  In most all cases, there is non-recourse bridge money available for these turnaround properties.  Depending on the situation, the price of this non-recourse money can be as low as 4.5% to as high as 15%.  These lenders will typically fund 100% of future Tenant Improvement and Leasing Commissions required to stabilize a property and will allow for a future funding for property upgrades as well.  Properties that are well-located in strong markets can get interest carry in order to torque the leverage beyond what the property is capable of servicing on its own while preserving the non-recourse status of the loan.   A year ago, deals that needed interest carry were recourse and most likely placed with banks.  While the banks are still active and recourse money can be borrowed at sub 4% range, it appears that the banks will be mostly active in the ground-up construction space as these non-recourse bridge lenders are very active and provide terms that are simply hard to pass up with the additional recourse risk being a component of the “slightly” cheaper bank debt.

A recent marketing of a retail “turnaround” property yielded several non-recourse lenders while most banks passed due to the amount of “heavy lifting” that was required to stabilize the property.   MCA received six solid non-recourse bridge quotes with the lowest pricing at only 6.5% interest.  The loan to total cost was nearly 70% while providing interest carry to fund negative mortgage payment during the leaseup.  This particular property had no LOI’s or new leases in place before closing.  These same bridge lenders are also very good at underwriting high leverage or in some cases 100% of cost loans for discounted payoff loans or “DPOs.”

Please contact me, Todd, at or any of the Senior Directors at MCA if you are contemplating a turnaround or DPO opportunity to learn more available financing programs that can enhance investment returns while minimizing recourse risk to the Borrower.