Bo Barron, CCIM

“Opportunistic Retail” - Sophisticated investors refuse to be fooled by the news and the naysayers. As we move into a new economic cycle and a flight to safety mentality drives asset class rotation, opportunistic retail investments abound. In today’s post I’ll share my thoughts on why opportunistic retail is where the smart money is being invested…

You’re probably wondering “Bo, what are you thinking…Opportunistic Retail?” Nary a day goes by when we don’t hear about poor retail earnings, store closures, and bankruptcy filings associated with name brand retail chains. The largest retail REIT in the market General Growth Properties (GGP) has been arm-wrestling with lenders negotiating loan extensions to remain solvent, so why am I recommending retail investments? If you’ve read my recent white paper you’ll know that I believe that adversity creates opportunity, and nowhere is this more true than in the retail asset class.

Savvy investors are now beginning to feed off the gluttony of investors who bought into the retail space at the top of the market by paying unprecedented premiums on buy-side cap rates. Think about all the properties ripe for repositioning and big NOI lifts that were completely unattainable for the average investor only a matter of months ago. Bottom line…If you’re interested in buying into the market as it turns upward now is the time to act.

ShareThis

Getting Your Property Financed

Being Capital Markets Savvy in a Down Economy by Bo Barron, Advisor Sperry Van Ness – Kentucky

I rarely have a conversation these days where the topic of financing doesn’t arise as a serious concern for my clients. When the economy is robust, and the capital markets are frothy, financing a commercial real estate transaction is a relatively simple matter. However during today’s recessionary times, the commercial capital markets are severely constrained. Not only is the supply of capital tight, but the demand may be near all time highs as well. Depending on which industry source you quote there is between $150 and $200 billion dollars of CMBS debt maturing in 2009 alone. This figure doesn’t include maturing loans from insurance companies, banks and other lenders, which means that many borrowers will be forced to secure financing in a market that presently offers little liquidity. Given the current lack of liquidity and financing options described above, only the savviest of sponsors with solid projects will be receiving attention from lenders and investors. In the text that follows I’ll provide you with an overview of the information you need to possess in order to speak fluent finance and to increase the odds of getting your project financed. The first thing to keep in mind is that financing serves multiple purposes beyond rate and term considerations. The proper financing strategy can allow you to increase project velocity, improve operating efficiency, conserve internal capital, increase leverage, and lower the overall cost of capital. Good sponsors focus on developing an integrated capital formation strategy surrounding acquisition, development, construction, refinancing and recapitalization initiatives. The following items are just a few of the things commercial borrowers need to address when seeking capital:

• The selection of the appropriate capital provider;

• Level(s) of the capital structure to be addressed;

• Operating considerations; • Control provisions;

• Rate, term, pricing and structure;

• Closing time frame;

• Third party requirements;

• Certainty of execution;

• Recourse provisions;

• Exit and pre-payment options;

• Inter-creditor or other multi-party agreements;

• Post closing servicing issues;

• The effect of the capital acquired on tax, balance sheet, future projects or portfolio considerations, and;

• A whole host of other value-added considerations.

Possessing knowledge and understanding of the commercial capital markets is a critical factor in not only determining the eventual success of a single transaction, but also an entire portfolio or operating business.

The first thing that borrowers must understand is that all capital providers are not created equal. There is a definite hierarchy within the world of capital providers, and understanding the value-ads offered by different capital providers is important in choosing a relationship. Understanding how to use different types of capital providers for different types of solutions/needs will be important to structuring the proper outcome. Approaching a lender for high leverage loan in today’s market without having your ducks in a row will prove to be next to impossible. With debt service coverage ratios (DCR) nearing or even eclipsing 1.3 for many asset classes, advance rates on senior debt have certainly constricted requiring more mezz and equity investments for most sponsors to put a deal together. Making matters even more complicated is that there is no longer a clear division between debt and equity in the commercial capital markets. Given the ever increasing complexity of financially engineered structured finance solutions, it is essential for borrowers to develop a detailed understanding of the capital markets, and the structured finance options available to them.

With the conservative advance noted above, it is critically important that you understand how to fill the increasing equity gap with the most affordable and effective capital markets solutions available. The optimized use of structured finance solutions is one of the few arenas that allow commercial real estate owners to dramatically impact leverage, efficiencies and economies of scale across all business lines including acquisitions, financing ventures and operating activities. Structured finance is best defined as financially engineering the proper blend of debt, equity, synthetic, derivative, and hybrid capital in order to resolve particular transactional needs that cannot readily be met by conventional senior financing alone. Structured financing allows for an engineered design and pricing of situation-specific financing instruments. Representative examples of typical situations that call for structured finance solutions include the following:

• Working around balance sheet or capital constraints;

• Shifting a higher percentage of the capital structure up or down in the leverage curve based upon current needs or market conditions;

• Attaining greater amounts of leverage at a lower blended cost of capital;

• Adding value and increased leverage to buyouts, yield-plays, recapitalizations, repositionings, and stress-induced financial restructuring;

• Shifting risk and better managing control at both the project and entity levels;

• Releasing trapped equity in single assets or portfolios;

• Conversion of illiquid assets into tradable securities;

While many would choose to define structured finance in narrow terms, it is rather the limitless ability to engineer hybrid, synthetic or derivative instruments. This level of flexibility makes the engineered solution provided by structured finance so valuable. While current capital markets conditions have restricted the use and/or availability of some products, typical structured finance instruments include the following:

• Senior and Junior Mezzanine Debt;

• Straight, Convertible and Participating Second Mortgages;

• Preferred Equity Structures;

• Bond Placements, Tax Credits and other Municipal Finance Alternatives;

• Index or Currency Linked Strips;

• Swaps, Options, Caps, Collars, Swaptions, Captions, etc;

• Credit Enhancement, Financial Guaranties, Standby Commitments;

Forward Commitments; Understanding how to maximize all levels of the capital structure through the use of structured finance techniques when developing the capital formation plan on your next transaction will help you create a much more effective and efficient execution. The following items are just a few of the benefits of understanding how to engineer the right capital structure:

1. Use all levels of the capital structure to move up the leverage curve: By using the proper combination of senior debt, subordinated debt and third party equity, even in this market it is still possible to aggressively climb the leverage curve and still maintain control of the project.

2. Use different levels of the capital structure to prevent project ownership dilution: By using subordinated debt (seller financing or mezzanine financing) to fill as much of the equity gap as possible you will lower your overall cost of capital while not being forced to give up as much ownership in the project as you would by closing the entire equity gap with a joint venture equity partner.

3. Work the Lenders: In today’s market, lenders will often negotiate with borrowers where there is a benefit for doing so. It is quite possible to get a lender to write down or restructure the current financing on a property or portfolio to keep from taking back non-performing assets.

4. Negotiating the proper type of equity joint venture can be critical to the financial success of a project: If you move up the leverage curve with the proper combination of senior and subordinate debt the amount of equity needed from outside investors is minimized. Using the right preferred equity investment structure can leverage the sponsor co-invest to a smaller percentage of the project equity requirement while still leaving the sponsor with the majority of project ownership.

5. Individual Investors vs. Institutional Investors: Decide early where you choose to seek your capital partners and investors and be willing to live with your decision. With rare exception if a sponsor can meet institutional suitability tests they will be better served by accessing commercial capital markets rather than dealing with individual investors. Institutional investors have more knowledge and flexibility when structuring transactions giving owners more operating flexibility. Institutional investors have deep pockets and can provide the appropriate level of financing to allow sponsors to engage on multiple projects at one time thereby creating the ability to grow their business with greater velocity when contrasted to the leverage provided by individual investors. Additionally most institutional investors prefer passive investments and will only exercise dilution or control provisions in the rarest of circumstances. Lastly, institutional investors often times can provide tremendous non-financial value adds in the form of knowledge base, intellectual capital, market contacts and the like.

6. Resist the temptation to do “one-off” project level financings: Disparate financings at the project level can at a minimum restrict a borrowers future ability to cost effectively monetize on value creation by subjecting the property to pre-payment issues in the case of refinancing or disposition prior to the expiration of lock-out periods. Worse than trapping equity at the project level may be the fact that one-off financings restrict the ability to pool the asset with the balance of the portfolio creating a lack of optimized leverage and timely access to credit which in turn can create capital constraints by slowing acquisitions activities or operating initiatives. Lastly, large portfolios or even smaller sub-portfolios created by a multitude of one-off financings can create a management nightmare. This is due to constantly maturing debt rollover which will subject individual assets to credit, interest rate and market risk. This type of risk is not present when financing at the portfolio level due to the ability to trade in and out of collateralized pools where pricing, sizing and structural aspects are known constants.

The year ahead will definitely be challenging with regard to capital markets issues. Understanding how to access and maneuver within the commercial capital markets, and effectively leveraging the many benefits of understanding how to work the capital stack to your advantage may be the defining difference in optimizing the scalability and efficiency of your commercial real estate venture.

Overview

The Big Picture

Even the most astute commercial real estate investors are no doubt perplexed as to what strategies and tactics will best serve them in 2009...So, what makes 2009 different than any other year for real estate managers and investors? A recession, a capital and credit crisis, a new administration, an unfavorable public opinion of the real estate market, and perhaps what is the toughest competitive environment in decades. Will 2009 be a banner year for principals and sponsors or will it be a total bust?

I suspect that for many who read this paper, that the poor economic outlook and the severe disruption in capital and credit markets might seem to indicate that it's a good time to stand pat until there is clear evidence that economic and financial markets have stabilized. However it is precisely this type of cautious behavior that keeps downward pressure on markets, creates no value for investors, and most importantly gates your ability to catalyze wealth creation.

Although many things can be learned as a result of analyzing other down market cycles from the past, history clearly tells us two things about falling market conditions: 1.) that the more severe the downturn, the greater the opportunities for those who are prepared to execute, and: 2.) More lasting and substantial wealth is created in down markets than in bull markets due to shifting equilibrium and the resultant transfer of assets which always occurs.

It has been said that "adversity breeds opportunity," and so the fundamental question you must ask of yourself is this: will you take a defensive posture and stay on the sidelines managing risk, or will you get in the game and play offense by seeking out and exploiting opportunities? In this white paper, you'll find a business case for developing an investment strategy that positions to you to take what the market is willing to give. You'll have the opportunity to read about how to create a blueprint that will prove a business case for identifying investment opportunities not despite market uncertainties, but because of them...

I hope that you find the information contained herein to be beneficial and I look forward to serving your commercial real estate investment needs in the Western Kentucky market in 2009. Thank you for your consideration.

Bo Barron

Introduction

Successfully Navigating the Down Market

Unique market circumstances require extraordinary planning and execution. While there is no doubt that commercial real estate is a very special business, it is nonetheless still a business, and as such, deserves to be treated as one. Those commercial real estate managers and investors who don't have a sound business model delivered with a certainty of execution in 2009 will find the market to present what appear to be almost insurmountable barriers, obstacles, and challenges. The six pillars of any good business model are as follows:

•1. A clearly articled vision;

•2. A sound strategic plan;

•3. Great tactical execution;

•4. Properly acquiring and leveraging talent and resources;

•5. The creation of a strong brand, and;

•6. The development and protection of competitive advantages.

You'll notice that when reviewing the Sperry Van Ness brand that there exists a subtle, yet all important distinction in how we approach business...We are not just commercial real estate "brokers" schlepping deals, but rather we are skilled commercial real estate "advisors" who take great care to add significant value to our client's business initiatives.

While many "brokers" tend to lead with deals hoping that if they throw enough of them up against the wall, something will eventually stick, Sperry Van Ness advisors take the time to align your goals and objectives with current market conditions so that while your competitors business plans have stalled, yours has increased velocity and momentum.

I will personally commit to not only understanding your investment guidelines, return hurdles, acquisition and disposition models, etc., but to also do everything in my power to help you align them with current market opportunities and to execute your strategy as seamlessly as possible.

The difference between an "advisor" and "broker" is that the advisor is interested in the client first and the deal second...not the other way around.

Creativity Equals Success

Kentucky 2009 - Operating Outside the Norm is the Norm...

As far as the Western Kentucky commercial real estate market is concerned, keep in mind the statement mentioned earlier that "adversity breeds opportunity." While the Kentucky market certainly doesn't resemble the frothy climate of 2005, it is nonetheless better off than many markets around the country. The difference today is not that opportunities don't exist, but that it takes more effort to identify them, and more savvy and sophistication to close them.

There is little doubt that we are currently experiencing one of the toughest markets in recent history. Today's investment sales market has been reduced to an environment of the "haves" and the "have-nots." Many will point to the economic woes, tight credit, and the constrained flow of funds in the commercial capital markets as being the main reasons for the tough commercial market. However while there is an element of truth surrounding the logic contained in the previous sentence, I believe it is simply easier for many buyers and sellers to blame the market and follow the crowd rather than adapt their acquisitions and dispositions plans.

As an example, the real opportunities in today's market are not found by following the herd mentality but can be found in the application of any of the following strategies:

•1. "Off-market" transactions: I routinely help my buy-side clients seek out assets that are not listed by retail brokerage firms. Going the extra mile in approaching principal owners on a direct basis negotiating with them on assets that are not publicly for sale pay big dividends for clients.

•2. Change Market Focus: Both buyers and sellers alike are benefiting from focusing on secondary and tertiary markets where there will be less competition for assets. Many of the Western Kentucky sub-markets have particular appeal during economic downturns.

•3. Change Asset Class Focus: Be open to asset class rotation to take advantage of market opportunities as they arise. Diversification has never been more important than it is in today's market. Look across multifamily, retail, office, industrial, hospitality, self-storage, net-leased, and raw-land asset classes.

•4. Think Trophy Assets: Only a few years ago, many trophy assets were simply not affordable. Take advantage of higher vacancies, lease roll-over risks, and financing issues to acquire a trophy property at less than premium pricing.

•5. Look for Joint Venture or Recapitalization Opportunities: Many of the best opportunities in today's market are not found in out-right acquisitions. Explore joint ventures that will allow you to co-invest with existing owners of assets in a fashion that will allow them to free up trapped equity or fund new developments.

•6. Renegotiate with your Lenders: If you debt is non-CMBS debt, but is portfolio debt still on the balance sheet of your lender, don't hesitate to inquire about buying the debt out at a steep discount. It is sometimes possible in today's market to buy-out the debt for only a fraction of the outstanding loan balance. This not only improves your balance sheet and your cash flow, but it frees you up to acquire other assets.

•7. Change Your Acquisition Process: Traditional acquisition time frames that were competitive 12 months ago will leave you on the outside looking in with today's bottom feeding environment. Be willing to make unsolicited offers, put up meaningful earnest money deposits and close quickly where it make sense to do so.

Bottom line...There is no better time to shed the herd mentality instinct to wait-out the market. True portfolio growth, enhanced return on assets, and increases in personal net worth are rarely achieved by sticking your head in the sand, and waiting for better times. I invite you to contact me to schedule an appointment to review your current portfolio and discuss strategies for maximizing opportunities in Kentucky in 2009. Best wishes for continued success...

Today's tight capital and credit markets are forcing many corporations and small businesses to become creative in their search for liquidity to free-up suddenly constrained balance sheets. In turning over every stone in the hunt for liquidity, many entities simply overlook the value of their corporate real estate assets. When an operating business, no matter how large or small, finds itself in need of low cost capital their real estate assets should be evaluated as a source of readily accessible quality capital.

Most corporations of any size and scale have investments in the land, buildings and facilities necessary for the successful operation of their business. While making corporate investments into real estate assets may seem to be a reasonable strategy at first glance, they are rarely investment or capital driven decisions, but rather these decisions tend to be cost driven operating decisions. In retrospect, operating decisions surrounding the ownership of real estate to operate your company usually fail to maximize the leverage and value of the land and facilities beyond what is typically provided for within traditional ownership and financing structures.

While a number of financially engineered solutions are available to maximize corporate real estate assets, the most commonly used structures center around Sale Leaseback transactions. Sale Leaseback transactions are popular solutions for the following reasons:

•1. Improved Financial Statements: By moving corporate real estate assets "Off-Balance Sheet," financing solutions are engineered to eliminate mortgages that are normally carried as debt on your company's balance sheet. The immediate boost in cash without offsetting debt can improve the overall financial health of a business. Book income typically increases in the transaction's early years, with rent payments less than the interest and depreciation under conventional financing. With the implementation of the proper financing mechanism, the book value of company assets is effectively understated - enhancing your company's Return on Assets (ROA).

•2. Financial Flexibility: Corporate real estate transactions are often not bound by formalized loan industry or REIT requirements, giving lenders flexibility to meet the operating needs of your business. Rents can be fixed for the full lease term without inflation adjustments or any percentage rent. Rents can also be stepped to be lower in the early years, or reset periodically to take advantage of improved credit, interest rates, or other unexpected financial and business contingencies.

•3. Operational Control: Most capital providers and investors offer programs and leases that will allow you to retain complete operational control of the property for as long as it is required in your business.

•4. Low After-Tax Cost: The lease payment under a sale leaseback structure is fully deductible over the lease term, making the after-tax cost to your company less than with alternative forms of asset-based financing, and less than the market rent you would typically pay. For federal income tax purposes, a company can only depreciate buildings and other physical improvements, but not land. Most sale leaseback solutions factor the value of the land into the rent. The rent is fully deductible, effectively enabling you to depreciate the cost of the land.

•5. Credit Tenant Property Can Provide Similar Financial Benefits To the Issuance of Corporate Bonds: If a business is deemed to be a credit tenant or its financial equivalent, its corporate real estate assets can be effectively used to secure management-free cash flow with exceptional liquidity and high leverage performing like corporate bonds while preserving the benefits that real property offers. Because of the secure character of credit tenant property investments, properties can be leveraged far more highly than traditional real estate. Based on the lease guarantee by the tenant, non-recourse financing may be arranged with a 1.0 debt coverage ratio, allowing for financing up to 100% loan to value. Income from an investment grade tenant over the length of a multi-year lease offers reliable returns comparable to those of corporate bonds. Credit tenant leases are usually written for terms ranging from 10 to 25 years. Lengthy terms eliminate concern about tenant turnover normally associated with real estate ownership.

•6. Near-Zero Volatility: Many "Sale-Leasebacks" today offer fixed rent structures providing full inflation protection. Because the key value determinant of credit tenant property is the long-term corporate guarantee, this asset does not experience the cycles affecting other real estate asset classes. Long-term, highly leverage financing removes interest rate risk and minimizes pricing volatility. Circumstances affecting traditional real estate, such as changes to surrounding property, local politics, and market swings have little impact on credit tenant property values.

•7. Liquidity: The long-term corporate guarantee of rental income and expense coverage combined with the tenant-based financing enable corporate real estate assets to be traded with exceptional liquidity not typically associated with real property. Most lenders will allow businesses to convert existing fixed real estate assets into cash at fair market value at what may be a premium over book value. Funding can also be used for new construction including the cost of the land acquisition. Proper use of corporate real estate as a financing tool will eliminate the need for a business to tie up capital or credit in land or buildings.

As an example, in many of the sub-markets in Western Kentucky you'll find many of the free-standing, single tenant retail buildings are owned by an investor and leased back to the company. Medical office buildings leased back to the physicians that occupy it have been particularly attractive to investors lately. A wide variety of sale leaseback structures are available from capital markets providers and investors who have a practice area dedicated to corporate real estate finance.

No matter the size or type of your company, when developing your capital formation strategy, make sure you evaluate your real estate assets as a viable vehicle for accomplishing your company's goals. Of course it is important to consult your legal counsel and accountant for specific tax implications.