N.Y. developers turn lenders chasing profits in construction boom
New York developer Silverstein Properties Inc. built a $4 billion pipeline of real estate deals just weeks after starting. None of the money was for buildings it will own.
The developer of prominent New York skyscrapers such as 3 World Trade Center has jumped into property lending as demand for financing grows and yields are more attractive. Silverstein set up its first lending venture earlier this month and already has a slew of potential deals going to projects in New York City. Others, including Oxford Properties Group, also have big plans to finance other builders.
"Supply and demand characteristics in New York and throughout the country are good — we think that there’s years to run in this cycle," Michael May, president of Silverstein's new lending venture, said in a telephone interview. "In New York, the dollars are big enough and Silverstein's footprint here is big enough that I think we could run the entire business just doing New York if we wanted to."
As big banks have pulled back, a flood of more lightly regulated nonbanks has rushed in to fill the void across industries. In real estate, that includes debt funds, mortgage REITs and developers, often backed by private equity or other institutional capital. Property research firm Green Street Advisors estimates that U.S. originations by these lenders surged more than 40% in 2017 compared with the year before to almost $60 billion, and should rival that of life insurance companies and commercial mortgage-backed securities this year.
The opportunity is partly due to what Silverstein sees as a "gap in financing" that has its origins in the 2008 financial crisis. Since then, large banking institutions have faced heightened regulation and become more stringent in underwriting projects. That has taken a toll on their ability to lend to the construction industry, where there tend to be more risks and higher costs.
"You end up with accounting treatment reserves and with regulatory capital treatment on a lot of these asset classes, which has become extremely challenging for banks," said May, who had previously worked at Credit Suisse Group and Cantor Commercial Real Estate Lending, overseeing the origination and distribution of real estate products. "We can be more nimble, move more quickly and we're not impeded by an overlay of rules and regulations that challenge our assessment of risk."
Silverstein hasn't closed on any lending deals yet. The company is also looking at financing projects in other U.S. markets including Los Angeles, Seattle and Boston.
Blackstone Mortgage Trust Inc., managed by a subsidiary of Blackstone Group, the biggest private-equity real estate investor, originated a $1.8 billion construction loan earlier this year for an office tower in Manhattan’s Hudson Yards.
Silverstein's lending platform is backed by a sovereign wealth fund and a pension fund with “deep pockets” and has no maximum loan amount.
Then there's Oxford, the property unit of Canadian pension fund OMERS, which has invested more than $3 billion in loans and plans to more than double that amount in three years.
A key opportunity for Silverstein is lending to projects that are too pricey from an equity perspective. The returns they get are still attractive, but less risky, May said.
"There's a lot of demand for capital and there's a lot of good quality assets being built, but maybe at pricing that we think is higher than we would want to operate," May said. "Those projects need capital, in a spot where we're very comfortable lending."
Foreign investors have also been betting on higher-risk loans to developers as increases in Libor, a major benchmark for global interest rates, make yields on U.S. developments more attractive, and help add liquidity to the debt market — more than "at any point in this cycle," said Aaron Appel, Jones Lang LaSalle Inc.'s vice chairman and head of New York City capital markets debt and equity.
"Despite the political environment, the U.S. is still the most stable place to invest globally of any country." He added that national property rights laws and federal efforts to elongate current economic growth have also favored foreign investment.
Debt fund investors believe that "if there's a decline in asset values, the lender is more protected than the equity investor," Dave Bragg, managing director at Green Street, said by phone. "The incentive for many players is the perception that returns on debt are higher than what one could underwrite on the acquisitions of real estate today."
The growing number of lenders has resulted in a market where capacity outweighs demand, especially for assets that already are generating income, Bragg said. Yields for riskier construction loans are higher and there are fewer lenders competing to provide them. Banks are still the primary source of that financing but are limited by regulation because of the longer time line and and larger amounts of capital required.
"Construction is one of the few spots where you can get to double-digit yields in this market as a lender," Silverstein's May said, adding that the company has a competitive advantage because of its experience as a developer and better understanding of the underwriting risk. Oxford's head of New York and global credit Kevin Egan also sees a gap in construction loans and high-yield loans and plans to make more.
Lenders in real estate have for the most part been prudent, but as more lenders rush in to capitalize on this opportunity, there are concerns that could lead to a decline in lending standards and a construction glut. The nonbank lenders are more lightly regulated, which means there is less transparency, said Peter Muoio, chief economist at Ten-X Research, a unit of Ten-X Commercial.
"Most real estate cycles ultimately reach a period of excessive construction," Bragg said. "If that happens in the cycle, the debt funds and mortgage REITs would be contributing to that and would ultimately lead to weaker fundamentals and perhaps lower asset values several years down the road."