By David DiRienzo, director — business development, at Talonvest Capital, Inc.
This is part two of a two-part series discussing the key drivers behind transaction volume and the steps owners can take to ensure they are well positioned going forward.
As highlighted in part one, despite substantial changes in the market over the past few years, the capital markets continue to offer quality financing solutions for real estate owners. Part two of this article series delves into two key drivers of current financing activity: elective refinancing to optimize the capital stack and the initiation of new business plans.
Given the plethora of value-add projects in the pipeline and the interest in undertaking new business plans as equity capital returns to the market, these financing strategies are taking on greater importance than in past years. Interestingly, elective refinancing and starting a new business plan are two scenarios where the borrower’s actions are optional because an impending maturity is not a consideration. For this reason, it is important that borrowers understand the nuances behind these strategies as well as the approach that a capital expert might take.
Elective Refinancing to Maximize Investment Performance
While loan maturities trigger many refinancings, owners run into a variety of circumstances where a refinance can add value to a project well in advance of maturity. Undertaking an elective refinance is done for three common reasons.
First, many owners prefer to de-risk a project by moving from a floating rate to a fixed rate. A common example includes instances where stabilized properties previously financed by floating-rate loans will perform better under a fixed-rate product. Furthermore, owners can maintain flexibility with loans that offer early prepayment structures that provide optionality to refinance in the future should the rate environment improve or should one choose to sell.
Second, regardless of the business plan or the status of the stabilization effort, owners may find that index rates, spreads or a combination of the two have moved in a favorable direction. Under these market conditions, an opportunity may exist to refinance into a lower cost loan. The goal of a refinance in this situation is to improve the investment yield by reducing the monthly interest expense, boost cash flow or create liquidity for investors.
Third, when an asset experiences significant market value appreciation, owners understandably begin to look for ways to extract equity trapped in the asset. The premise is that a cash-out refinance allows the owner to pull equity from the property and use it to invest back into the asset or distribute to investors.
Real World Example: Bringing Creative Solutions in Challenging Market Environments
While banks were pulling back from the non-recourse bridge loan market, Talonvest recognized that life companies and debt funds remained active and offered excellent bridge packages. We successfully tapped our network to source a non-recourse, fixed-rate bridge loan on a transitional property from a life company that offered a rate lock at the time of commitment. As a result, our client reduced exposure to interest rate risk and obtained a loan with an all-in rate that was 18 percent below the prevailing rate on floating-rate bridge loans with recourse from banks.
Commencing a New Business Plan Requires Tailored Financing
Many commercial real estate investors are launching new investments, and a lot of these are centered around development, adaptive re-use or redevelopment and value-add projects. Select acquisitions are underway when the math pencils, and the transaction market is picking up, albeit slowly.
In today’s market, capital providers have the luxury of choosing to finance only the most compelling projects, while declining to extend financing to many others. As long as this dynamic prevails, owners will face an uphill battle to capture lender interest, so the importance of presenting the project in the best possible light is of critical importance.
A common example of a business plan that calls for new financing is the kickoff of a development project. Developers often start the project with a construction loan and rely on it through the construction phase and beyond. Once the project is leased and stabilized, many owners look to refinance into a permanent loan, while others decide to refinance into a bridge loan upon completion of construction, either before or during lease-up.
It is important for developers to know that construction financing remains difficult to obtain because lenders are focused on lending only to developers with longstanding track records and the most promising business plans. Furthermore, construction loans carry more risk than other loan types, and lenders may compensate for this by lowering leverage, charging a higher rate and/or requiring recourse.
Real World Example: How a Capital Expert Can Deliver New and Competitive Lending Sources
Talonvest sourced a relationship bank to fund a construction loan for a client at 25 basis points below prevailing market pricing, with additional rate improvements set to kick in upon the completion of certain project milestones. This was only possible due to the lender relationships we maintain and our ability to create competition among lenders at a time when many banks were avoiding the construction loan market.
Final Thoughts on the Current Drivers Behind Financing Activity
Demand for financing in today’s commercial real estate market is being driven by factors like business plan progression, a desire among owners to reduce risk, the need to replenish operating reserve and the commencement of new business plans. Each scenario presents unique challenges, and it is important for owners to work with a capital expert who can identify lenders offering the best pricing and terms. For example, we recently achieved $1 million in interest expense savings for a client where we used our competitive bid process to negotiate a significant improvement in the winning lender’s credit spread from where original quotes came in.
As we move forward, it’s clear that markets will continue to evolve. Already, near the end of the fourth quarter of 2024, we’ve witnessed a notable uptick in transaction activity, particularly as buyers seek acquisition financing. With several key factors in play — ranging from the conclusion of the U.S. Presidential Election and the Federal Reserve’s continuing interest rate cuts to an improvement in overall market sentiment — momentum should continue to build into 2025. Capital providers, flush with dry powder, are becoming increasingly competitive, creating better opportunities for borrowers.
At Talonvest, we’re at the forefront of these dynamic market shifts, enabling our clients to capitalize on real-time changes and adjust their strategies as needed to ensure success. Borrowers can significantly enhance their outcome by working with a capital expert who serves as a partner and takes the time to understand the business plan, objectives and motivations behind the financing. Furthermore, connecting with a capital expert early in the process can help owners secure financing on terms that push business goals forward at every stage of the asset life cycle while alleviating the burden of managing competing financing packages from dozens or even hundreds of capital providers.
Read part one of this series here. This earlier article focused on best practices for restructuring debt as a project evolves.
David DiRienzo is a director of business development at Talonvest Capital, Inc. where he is responsible for sourcing clients and developing new business opportunities. His commercial real estate experience includes over $1.5 billion of closed financing transactions and over $250 million of asset acquisitions during his six years working on the principal side of the business. David can be reached by email at ddirienzo@talonvest.com.
Talonvest Capital, Inc. is a content partner of REBusinessOnline.