Our Perspective 6/ 5/ 2017

Follow the capital: tertiary and secondary markets no longer a commercial real estate afterthought

For those looking for CRE financing in tertiary and secondary markets, conventional wisdom says that it will be difficult. With familiar storylines about CMBS lending below historical levels and the inherent increased risk for investors, tertiary and secondary markets tend to get a bad rap. But taking a deeper look into individual markets across the country reveals a different perspective. While they have their own set of challenges, tertiary and secondary markets merit stronger consideration.

We asked five top producers about their perspective on real estate opportunities in their markets. They shared their insights into the opportunities and challenges in Westchester and Rochester, New York; Charlotte/Raleigh, North Carolina; Cincinnati, Ohio; and San Antonio, Texas.

San Antonio, TX – Bryan Leonard
1. What property type/niche are seeing/hearing about in your market? What conditions make this possible?
San Antonio has long been characterized as a very stable market and for good reasons. It has a diverse economic base, perceived high quality of life and a very reasonable cost of living. It was named as the number two place to visit in the world on a recent list published by Budget Travel and consistently ranks in the top 15 of US event destinations. Many people don’t realize it is the seventh largest city in the country.  In recent years, the San Antonio CBD has largely been a tourist destination but that is no longer the case. San Antonio’s CBD is undergoing a residential and commercial renaissance. For the first time since 1989, a new $142 million 460,000 sq. ft. office tower designed by the world renowned Pelli Clark Pelli architecture firm is under construction in the CBD. Numerous multifamily and entertainment venues have also been and are currently under development. Additionally, the suburbs are doing well and seeing a mix of office, retail and multifamily construction as one would expect given San Antonio was ranked sixth in population growth in the US among big metros last year. Housing starts continue to be solid and demand is outpacing supply with an estimated 3.4 months of inventory available according to local sources. We have seen many people relocating to San Antonio from other parts of the state and nation for work in recent years. These factors support healthy real estate markets locally in the broad sense. There does seem to be a niche in the affordable/workforce housing space in this market and several developers and local municipalities have capitalized on those opportunities. San Antonio is also a good hotel market given its strong position in the tourism industry.

2. What type of borrowers/lenders are in your market? For example; is it primarily agency or are bank and life companies also part of the mix? Why?
Borrower profiles in our market range from local to national, international and institutional. We do have quite a bit of interest and investment from investors located in California as well as the northeastern and southeastern part of the country. In the last several years, wealthy families with diverse business interests from Mexico have been significant real estate investors in San Antonio. It is a great relative value market when compared to the gateway markets as competition for product can translate into very thin investment returns. The San Antonio market offers investors stability with upside potential and real estate is still priced quite reasonably. NorthMarq is active with all lender types including life companies, agencies, CMBS, banks and other balance sheet type lenders in San Antonio. I would summarize by observing that San Antonio enjoys very good capital liquidity when it comes to the commercial and multifamily real estate markets and there is robust interest in investing here from a wide variety of investor types.

3.  What are the unique challenges facing your market?
Like many metropolitan areas experiencing strong growth, San Antonio is working to insure highway infrastructure keeps up with increased population and traffic. Our airport is undergoing an expansion with modernization. More frequent direct flights to key destinations will be important to future growth as well as the continued strong performance in the convention and tourism business. Our convention center is state-of-the-art and San Antonio is focused on continuing to be a leader in that very competitive industry. Like any growing city, strong pro-growth leadership will be necessary to perpetuate economic growth. We are fortunate to have a strong city manager as the city is in very good financial health and maintains excellent bond ratings. San Antonio is somewhat unique in that our water supply is derived from underground resources as opposed to surface resources. Long term plans to address and guarantee that resources will be plentiful for future generations are also in place and new avenues to supplement that plan are constantly being evaluated and implemented.

4. What are the unique opportunities present in your market?
San Antonio has a unique combination of resources and geography that contribute to its desirability. It has a culture unique to South Texas and a perceived high quality of life. As previously mentioned, the cost of living is low relative to many other places and weather is favorable in that winters are generally mild, making outdoor recreation very accessible just about year around. The economy is based on a diverse mix of industries such as tourism, import/export, manufacturing, healthcare and bioscience, aerospace, financial services and military. San Antonio is home to mission critical military bases and other governmental operations and is the epicenter of the burgeoning cybersecurity field. Due to the low cost of power and general lack of significant weather events, large data centers have located in San Antonio. For example, Microsoft recently purchased land to build a $1 billion facility that is in addition to two data centers they already occupy in San Antonio. We expect that San Antonio will remain a dynamic and attractive investment market across the property type spectrum for both investors and lenders alike for reasons that seem to have always held true here—steady, measured growth absent of volatile peaks and valleys.

Cincinnati, OH – Susan Branscome
 1. What property type/niche are seeing/hearing about in your market? What conditions make this possible?
Within tertiary markets, lenders tend to be most comfortable with apartment and retail properties. Industrial and office are not as popular in terms of property types in tertiary markets. Industrial properties are usually located in established industrial locations and require access to an interstate system, which many smaller towns do not possess. With office properties, growth and success depend upon a strong local economy and job growth, neither of which tertiary markets often have. Apartment and retail properties are supported more by consumers rather than commercial activity, making them preferable property types to lenders in tertiary markets. These retail and apartment properties must have exhibited strong historical income and must be well located. Tertiary markets, which have several employers and not one dominant employer, are preferred by lenders.

2. What type of borrowers/lenders are in your market? For example; is it primarily agency or are bank and life companies also part of the mix? Why?
In tertiary markets we typically see local borrowers versus national borrowers electing to develop and own properties in smaller markets. These borrowers know their markets and are comfortable with the risk of these investments. Some life companies will choose not to lend in tertiary markets given the default risk is higher with the smaller population levels, yet many life companies see tertiary markets as a place to obtain lower leverage loans and higher interest rates. So long as banks have a presence in these smaller markets or the market is in their lending “footprint”, they will likely consider lending in these communities. Both agencies, Freddie Mac and Fannie, will consider lending in tertiary markets although Fannie seems to have a bigger appetite for smaller communities.

3. What are the unique challenges facing your market?
Tertiary markets face the challenge of being so small it might be difficult to attract a lender which will consider a 75 percent loan-to-value loan. Borrowers which have loan balances at this level might find it difficult to pay off the loan without additional capital placed towards the transaction. Tertiary markets have the unique challenge of based upon its community size, there is risk of employers and companies leaving for larger cities causing population decrease.

4. What are the unique opportunities present in your market?
Lenders are not as enthused about lending in a smaller market versus a larger market. CMBS lenders are more likely to have fewer issues with the community size than life companies. Agencies and commercial banks therefore present an opportunity to do more business with CMBS/conduit lenders at higher leverage levels for borrowers.

Rochester, NY – Sam Berns
1.  What property type/niche are seeing/hearing about in your market? What conditions make this possible?
We are seeing many adaptive re-use projects located in city centers of Upstate New York. These include vacant building conversions to apartments, parking lot conversions, office to hotel, class “C” office to class “A,” and a resurgence in CBD retail. We believe this is a result of millennials desiring an urban lifestyle and needing the amenities required. This coupled with alternative forms of transportation such as Uber and Lyft will make car ownership a non-necessity.

2. What type of borrowers/lenders are in your market? For example; is it primarily agency or are bank and life companies also part of the mix? Why?
We are seeing smaller regional banks and credit unions taking the lead on the construction phase of CBD conversions. Agencies such as Freddie Mac and Fannie Mae are available for the take-out financing for these multi-family projects as they stabilize. Life companies remain interested in lower loan-to-value transactions with solid leasing to established credits. They like the lower loans per square foot that many of these conversions demonstrate.

3.  What are the unique challenges facing your market?
Many of the Upstate New York markets are stable and not exhibiting the growth being experienced in other cities. In some ways this helps as lending institutions prefer stable economies as opposed to others which may exhibit steeply shaped growth and contraction patterns.

4. What are the unique opportunities present in your market?
Our regions resilience in recessionary economic cycle’s couple with slow growth that provide lenders with a consistent and stable market to do business in.

Westchester, NY – Robert Ranieri
1. What property type/niche are seeing/hearing about in your market? What conditions make this possible?
Multifamily remains the base of transactions in Westchester County and Fairfield Counties though some concerns have arisen regarding oversupply in the more urban markets. Most development is transit oriented. Suburban areas are typically retail driven as the markets are littered with single family homes. Retail is mostly small strip centers and there has been good trading activity in both Westchester and Fairfield Counties creating strong acquisition lending opportunities. The retail demand is for supermarket anchored centers. Office space is slowly coming out of the basement, though still seeing average vacancies of 20 percent. The Westchester County market saw a 1.8 percent decline in employment in the first quarter of 2017 which puts a slowdown on office space recovery. Fairfield County was down just 0.5 percent in the first quarter but office is driven mostly by larger spaces leasing or coming to market. Leasing activity has been strong in Fairfield County, driven by Stamford with 237,958 of the nearly 630,000 square feet (up 80 percent year over year) in the first quarter. Vacancy increased by 240 basis points, but this was due primarily to 550,000 sq. ft. coming online between two properties in Stamford and Norwalk. In general, the market is in good shape.

2. What type of borrowers/lenders are in your market? For example; is it primarily agency or are bank and life companies also part of the mix? Why?
Borrowers in Westchester County tend to lean more towards bank lending, having smaller portfolios, and accepting the recourse that banks require in favor of a simple underwriting process and competitive rates. Life companies remain competitive for those borrowers looking for non-recourse but cannot always compete in the market on leverage. Agency lending is in the mix for borrowers who have experience with the more detailed underwriting process but they are not always competitive with the banks on rate for new customers with smaller portfolios. There is still many family owned borrowers in Westchester and Fairfield although the office sector is dominated by larger institutional players. The new multifamily development is also mainly larger institutional players.

3. What are the unique challenges facing your market?
In the urban areas of both Westchester and Fairfield Counties there has been some concern of oversupply in the multifamily market. Westchester County is expecting over 1,300 units to come online in the next two years while Fairfield County is expected to see over 1,500 units. Demand, while steady in the markets, is expected to lag behind these numbers creating an upward trend in vacancies. Westchester should fare better as inventory is more spread out, but Fairfield County is already one of the highest average vacancies in the region at 7.4 percent. Both these counties are experiencing higher real estate taxes and some movement out of the area to cheaper cost options.

4. What are the unique opportunities present in your market?
There have been limited sales in Westchester County, but Fairfield County saw 18+ retail properties traded in 2016, creating opportunities for acquisition financing in the market. Larger scale buyers and anchored centers allow for life company executions. Real estate fundamentals are still relatively strong but Westchester and Fairfield do well when NYC does well. Any downturn there, hurts us here.

Charlotte/Raleigh, NC – Dave Stewart
1.  What property type/niche are seeing/hearing about in your market? What conditions make this possible?
Multifamily is of course the hot property type in Charlotte as well as growth areas of the southeast. Most news headlines are focused on the class “A”/Dog Wash/Rooftop pool/urban infill structures but there is a huge market for class “B” and workforce housing in the areas surrounding major metropolitans. It is estimated that over 150 people are moving to the Charlotte MSA per day. Not all can pay $2.00 PSF rents so they live in nice communities in the suburbs and commute. The values for these garden-style complexes has increased at a rapid pace in the past two-to-three years and their owners now have significant capital to deploy.

2. What type of borrowers/lenders are in your market? For example; is it primarily agency or are bank and life companies also part of the mix? Why?
Borrowers in our market are accustomed to bank loans. The personal guarantee is an annoyance but not always a deal killer. Banks have been our primary competition. Life companies seem to provide the sweet spot in terms of decent leverage, non-recourse and ease of execution so many are flocking to this financing type.

3. What are the unique challenges facing your market?
There have been some political decisions that have affected development projects but it doesn’t appear that it has bled into the acquisition side. There is some cause for concern with oversupply of apartments and office; and although the demand may lag for now, the economics will soon catch up.

4. What are the unique opportunities present in your market?
Those familiar with our market and have experience investing here know when and where to pick their spots. It is nice to reward clients that have been investing in this community for a long time with lenders who are actively seeking their deals. The Southeast, in particularly Charlotte, is a hot bed of activity and should continue to be for quite some time.