For real estate companies, capital strategy during a crisis is all about trust
Nothing reminds you of the importance of savings like a disaster. The COVID-19 pandemic has woken many up to the importance of “rainy day funds.” In fact, the overall U.S. personal savings rate was higher than ever in the early months of the pandemic, government data showed, though studies found there were disparities in who was able to save.
The same is true for the business world. Many investors and lenders are holding back capital to help them weather the storm if the economy struggles to recover.
For real estate, this means that sourcing capital might look different than it did at the beginning of the year. The way that capital is raised depends on who is raising it and what it is for. But one factor remains true whether a company is sitting on a pile of cash or struggling to stay solvent, a small family office or a national real estate investment trust (REIT): Trust matters.
Reputation is one of the most important currencies when it comes to raising money in the property industry. Even as interest rates have hit all-time lows, access to commercial loans has gotten tighter. Lenders want to limit their risk exposure, too, and so they are often only lending to their most reputable applicants. This, as well as a struggling commercial mortgage-backed securities (CMBS) market, has pushed lending spreads to historic levels. Many of the larger banks have tightened their lending for a time, which has made space for more “special service” lenders to step in. These lenders have a much different approach to many deals, so terms of loans being originated at the moment vary widely.
FLOATING A LOAN
There is an old saying that says, “The best time to borrow money is when you don’t need it.” Some property companies that have been able to build up large cash reserves are sourcing new loans in order to take advantage of distressed assets. Even though the cash on hand goes a long way in making a lender more comfortable with the loan, purchasing distressed properties has its own list of possible pitfalls. These companies will have to prove to lenders that they have both the funds and the ability to turn these underperforming buildings into profitable ones. They also need to build their case that their proposed use of funds will be enough to get them through what is still an unknown amount of time.
Other property firms might find themselves in a bit of a pinch due to rent shortfalls. Borrowing money while struggling with non-payment and vacancies is a hard road, but anyone going this route should know that they are not alone. Many borrowers are going back to their lenders for forbearance and renegotiation of terms. As hard as it may be to lend on a struggling property, lenders will likely choose this route over foreclosing on a property with such an unknown market. Which companies they choose to give a lifeline to has everything to do with their relationships and reputations.
Just as the lending landscape has changed, so too has the investment world. Publicly traded REITs saw their values tumble in the dark early days of the pandemic. Some have been able to reassure investors of their long-term value, but few have recouped their pre-COVID-19 stock prices. When it comes to raising money via equity, LPs need transparency to help them understand that any investment revenue shortfalls will ultimately strengthen their position in the long run. For large firms like Blackstone, who recently raised a record-breaking $26 billion real estate fund, low interest rates have made their returns look more attractive. There is no doubt that the size and sophistication of one of the largest real estate investors in the world helps minimize the perceived risk of these investments.
Smaller firms have a harder time raising money on reputation alone. Many instead look to raise money on each deal. To help build trust in a new project, smaller firms must be transparent about other similar deals that they have done in the past. There are still many who try to withhold as much information about past deals as possible. They often feel like they don’t want to give away their playbook. But this type of transparency is critical when creating trust, especially with investors new to a company’s network.
One of the hardest tasks for any property company right now is raising money for a struggling asset. Investors know that more debt or additional equity will likely lower their investment’s value. While this can lead to some hard conversations, investors often understand that even though propping up a struggling building is painful, it is a better outcome than going into default and losing their investment altogether. In the end, a clearly communicated and well-executed recovery strategy can lead to more trust between investor and sponsor.
THE TRUST FACTOR
When the lending landscape starts to level out, we will likely see a new world in which the value of building a relationship is calculated and optimized, just like the interest rate. This strategy has been used by long-standing real estate families for a long time. Many have been able to build a reputation and rapport among the world’s top lenders to give them a competitive advantage when times are good, and a lifeline when unexpected problems occur. Costs will always be important in any financial equation, but moving forward they will increasingly be weighed against other variables like equity and goodwill.
Just as people tend to be tighter with their money during crisis, so do lenders and investors, and trust becomes one of the most important factors to sourcing capital. The strength of a property firm’s financials will always be important, but so are other aspects of the company. Even though reputation does not show up on a balance sheet, it can be the difference between success and failure in today’s volatile property landscape.