Northern California debt and equity market

Northern California debt and equity marketAs the economic recovery hit full swing in gateway markets in 2013, San Francisco witnessed the ready availability of various pools of debt and equity.

Life Insurance Companies remained the best choice for historically low-rate, mid-leverage loans on well-leased, core assets and have been the most conservative recently – requiring 80 percent or higher occupancy and minimum debt yields of at least 8.5 percent. In assets with occupancy in the low 80 percent range, some implement funding holdbacks until certain lease up hurdles are met.

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Northern California debt and equity marketBanks provided competitive, shorter term, mid-leverage funding and differentiated themselves by their ability to provide future funding on projects requiring upfront capital investment to unlock their potential value. Bank debt was available on a non-recourse basis in 2013 but was highly sponsorship focused. Banks also provide maximum prepay flexibility. Banks are very sponsorship focused but can be flexible on lending criteria. To help with capital improvements, banks offer prorated future funding and in cases of low occupancy – burn off recourse clauses.

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Northern California debt and equity marketCMBS issuance increased from $48B in 2012 to more than $90B in 2013 – though still well below 2007 peaks of $229B. CMBS lenders were willing to provide higher leverage, lent in secondary markets and demonstrated the ability to work in front of mezzanine debt. CMBS lenders, like Life Insurance Companies, aim for 80 percent or higher occupancy but are more willing to lend on Class B assets or Class A assets in secondary markets. Additionally, CMBS lenders usually include debt service coverage covenants of 1.25x with cash flow traps imposed if the collateral’s cash flow falls below agreed upon levels. However, CMBS debt may be interest only from two years up to the term of the loan – depending on leverage level.

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Northern California debt and equity marketCMBS debt-underwriting standards have certainly tightened from the boom days of the mid 2000’s. Leverage levels are lower, debt service coverage requirements are higher, and lenders are more selective than in their heyday. However, CMBS loans still offer up to 75 PERCENT leverage with the ability to work in front of mezzanine debt which proves to be attractive to an array of borrowers.

Investors seeking higher leverage on assets outside of the Central Business District often find CMBS debt to be a viable financing option. CMBS debt is available in markets in which Life Companies have yet to return after the recession and provides terms longer than those offered by banks.

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Northern California debt and equity marketOn the positive side, CMBS loans offer a high (up to 75 percent) leverage option in “B” markets. In certain cases lenders are also willing to work in front of mezzanine debt. Though debt service coverage requirements have tightened since the mid 2000’s, they remain reasonable – usually in the 1.25x range. CMBS debt may also be interest only from two years up to the term of the loan – depending on leverage level. On the flip side, being a securitized financial product, CMBS loans offer the least flexibility in troubled scenarios. CMBS loan docs include structure to protect the interest of their bond holders. These covenants, when triggered, can greatly inhibit the operational autonomy of ownership. CMBS loans are also inflexible to prepayment – requiring yield maintenance prepayment to ensure bond holder yield.

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Northern California debt and equity marketInstitutional, joint venture equity was also available for office and residential development. San Francisco proved to be an active, and lucrative, market for residential JV equity placement in 2013. Strong demand has propped up a staggering shortage of new supply, a booming tech sector, and increased foreign investor interest.

In San Francisco, 2014 is poised to start off where 2013 left off with lenders set to increase allocations. Extremely low cap rates have driven yield hungry investors out of the city and into other Bay Area markets. Financing has been, and will continue to be, available throughout the region. There are a substantial number of experienced developers evaluating opportunities – most will require joint venture equity and construction financing.

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Northern California debt and equity marketIn 2013, we executed almost equal amounts of debt and equity deal flow. We witnessed an active market for acquisition financing across the major asset classes and a spike in refinancing interest from long term holders hoping to take advantage of historically low interest rates. Rates varied throughout 2013 due to fluctuations in treasury rates but lenders stood firm to general location, occupancy, debt yield, and debt service coverage requirements. Attractively priced construction debt was also available for condo, residential, and industrial development with experienced sponsorship. Due to strong market fundamentals and a drastic lack of new supply in the city, residential development JV equity was also available to the right sponsor.

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Northern California debt and equity marketIn general, foreign investors are looking for stabilized, “A” assets, in the core submarkets of the city. Some see it as a safe, long term, alternative to park money which allows them to underwrite higher acquisition prices. These buyers tend to be conservative in nature and require low leverage, long-term financing – if any financing at all.

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John Manning Managing Director Jones Lang LaSalle’s Capital MarketsJohn.Manning@am.jll.com+1 415 395 4953

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