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Sunday, 13 October 2013 22:00

Bridging the financing gap: New funds could inject $220M to spur commercial development

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Commercial real estate developers in West Michigan could soon get some much needed relief from their struggles to access bank financing.

Still smarting from the millions in losses they incurred from foreclosed and repossessed properties, banks are keeping the purse strings tight on loans for commercial real estate projects. That has developers facing a financing gap in the market as the economy improves.

“There is a (financing) gap out there,” said Michael Price, chief executive officer of Grand Rapids-based Mercantile Bank Corp. “There are lots of good ideas that have come not only in the real estate market, but in manufacturing and other commercial opportunities where there just needs to be that level of debt that has a bit of higher risk profile than what a traditional bank financing package looks like.”

With developers and banks finding it difficult to work the numbers on many potential projects, that’s left some in development limbo, Price said.

There may be some help on the horizon. Two new funds expected to hit Michigan markets next year with up to $220 million in project financing could help close the financing gap.

The Michigan State Housing Development Authority (MSHDA) announced on Sept. 25 that it is launching a possible $100 million mezzanine fund with a focus on providing financing to urban multi-family, mixed-used residential projects across the state.

Also in September, MiBiz reported Lansing-based Great Lakes Capital Fund, via its Develop Michigan Inc. economic development arm, is working to close a $120 million offering for its Develop Michigan Real Estate Fund LP. Company officials say they plan to use the fund to provide capital for a program that would offer loans to commercial developers across the state.

It’s often the case that developers and entrepreneurs just don’t have access to the necessary equity that would make banks comfortable in extending the financing needed to push a project forward, Price said. Banks also just went through an intense period of trying to shed foreclosed assets from their balance sheets and salvage the losses from collapsed deals. In essence, they’re not in any hurry to risk adding more bad debt, he said.

Developers say they can typically get a bank loan for 50 percent to 60 percent of the total cost of a deal, but while they’re willing to put some equity into the projects, they’re still often left with a 30-percent funding gap. That’s created a need for a funding source that’s willing to come in and be last piece of capital that fits between senior debt and equity so that deals can move forward, said Chris LaGrand, chief housing investment officer at MSHDA.

With the availability of these funds, owners and developers have more financing options in structuring a difficult deal and more investors would have reason to invest in Michigan, LaGrand said.

Kalamazoo-based developer Tom Huff, owner of Peregrine Realty LLC, said the new funds could help fill a lending gap that’s been making it difficult to finance projects.

“It seems like these are great ideas that just open more options for developers,” Huff said. “Right now, the banks are timid and the appraisal market is also timid, so (these funds) make some sense.”

It’s no surprise that banks tightened their underwriting standards for property developments after the recession.

Local banks accumulated millions in foreclosed and repossessed real estate on their books in the recession. Deals with just one Holland-based developer, Scott Bosgraaf, left banks holding roughly $24 million in unpaid real estate loans and bad debt.

But Dan Yeomans, whose turnaround firm has been involved in the sale of $12.6 million of those foreclosed assets, doesn’t think developers should bear all the blame for the banks’ losses. Bad lending practices were often just as much to blame as over-extended developers, he said.

“I don’t even know how some of those loans were given,” said Yeomans, president of Amicus Management.

As the economy has improved, banks have gotten rid of foreclosed or repossessed properties, what’s known as “other real estate owned” or OREO. Locally, Mercantile Bank Corp., Macatawa Bank Corp. and Independent Bank Corp. combined have cleared their balance sheets of $17.1 million in OREO between Dec. 31, 2012 and June 30 of this year.

But because banks are reluctant to lend even as the economy has picked up, developers can’t assemble enough project financing to be able to meet the demands of the market. That’s where the new mezzanine financing could help, even if it’s at a higher interest rate and adds complexity to the deals, sources said.

While the new funds could make deals more complex in terms of layering different financing mechanisms and necessary paperwork, Price said the extra due diligence is worth it for a good project.

“In working a little with these types of funds and entities, they’ve made it fairly easy to work with, but of course, that’s always in eye of the beholder,” he said. “I’m not going to sugarcoat it, but every time you have another entity involved, that always includes another layer of paperwork and additional triggers and holds that need to be put in place. But all things considered, we think it’s eminently worth it for the entrepreneur or project team to spend the time.”

The process shouldn’t be so onerous that project managers will have to go out and hire a tremendous legal team to tackle the work, he said.

In the current market, many projects rely on the ability to secure building incentives primarily from state and local governments. At the same time, some incentives such as Renaissance Zones are retiring. Other incentives like the Michigan Economic Development Corp.’s Community Revitalization Program can help deals get off the ground, but the funds are always distributed on the back end of a deal when the project is complete.

Huff said his experience is that banks are reluctant to loan any more than 70 percent loan to value for projects despite the demand for urban residential development in many communities across the state. Those communities “need this kind of injection,” he said.

“This kind of keeps the momentum going,” Huff said. “There is definitely risk involved, but there is demand.”

Working in partnership with banks, MSHDA wants to identify a pipeline of deals that could unlock with the help of mezzanine debt, LaGrand said.

Given MSHDA’s strong portfolio of past successful projects, LaGrand believes the organization can convince investors to get involved in the Michigan market.

“We believe we have the history and market intelligence of doing deals in the state since 1960 that investors will find useful and attractive,” he said. “We’re thinking that we can offer investors an 8- to 10-percent yield, and the cost of the funds is around 14, 15, 16 percent. We think deals would pencil at those numbers.”

Right now, mezzanine debt is offered at around a 25-percent interest rate in some markets, which LaGrand said is a “go-away price.” Investors know deals don’t pencil at that rate, but initial conversations with investors have been positive, LaGrand said, noting the experience and market knowledge MSHDA can bring to the table.

The mezzanine fund is seeded with $25 million of non-taxpayer MSHDA reserve funds.

“We obviously believe this fund is going to provide a good return, which is why we’re moving the money,” LaGrand said. “We’re probably looking at the middle of next year for the first closing.”

The fund’s target investment is mixed-used multifamily housing in urban cores, the cost of which can range widely. LaGrand hopes to unlock primarily large-scale multi-million dollar developments. One stipulation to access the financing: Projects must have at least 50 percent of their units set at market-rate values.

“We want to get as many strong deals into the pipeline as possible,” he said. “Ideally, we want to be 10 to 30 percent of the investment cost of the deal. So if our target investment might be $10 to $20 million — depending on what percentage of the deal we are — you’re talking a $50 million real estate investment. That’s sort of the base level, and we can go higher.”

Given the potential returns for investors and MSHDA’s track record, Price of Mercantile Bank said he thinks the fund makes sense. He expects investors are really going to kick the tires on projects because of it.

“It all depends on the risk profile of projects,” he said. “(Investors) are clearly going to demand a higher return, but they are going to fill that gap that we think is going to allow some ideas and projects to go that may not have come to fruition — and hopefully provide a lot of job growth.”

Read 4694 times Last modified on Friday, 11 October 2013 10:57

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