Leonard Wineburgh has been a commercial mortgage broker for some 40 years, although his work today hardly resembles those early days. Wineburgh played a critical role recently in a new $25 million condominium project in Chicago that required lining up an 80% loan-to-value mortgage, a 15% loan-to-value mezzanine deal and an equity partner. The borrowing developer put a mere $600,000 into the deal yet stands to reap millions if the project performs well. Without the mortgage broker's Rolodex of investors and backers, the condos wouldn't have made it to first base.
This is quite a contrast to the more courtly process to which Wineburgh, known as “Bud” to his friends and colleagues, was first introduced. “Thirty years ago the loans were all conventional mortgages at the same price and for the same term lengths,” said Wineburgh, president of Chicago-based Dwinn Shaffer & Co. “Nobody worried about things like prepayment penalties because there were none. You only had a handful of lenders to work with, so the search for a loan was not very complicated.
“Today, loan offers come with all kinds of provisions that you have to sort through,” Wineburgh added. “Bankers and brokers have to oversee appraisals and Environmental Protection Agency and engineering reports, and all kinds of other paperwork that didn't exist 30 years ago. It's a much more sophisticated business today.”
So sophisticated, in fact, that the choice of the right mortgage broker or banker can make or break deals. With a wealth of lending contacts, brokers can find the lowest interest rates for their clients, negotiate away irksome provisions such as personal guarantees, locate stop-gap financing when a conventional loan comes up short and help ensure that closing arrives on schedule as promised.
For both the first-time borrower wading into the shoals of commercial mortgage lending and the most seasoned REIT executive, the mortgage broker navigates the loan process through the obstacles that inevitably crop up to threaten even the simplest applications.
Indeed, brokers have become such an accepted part of the lending landscape that only a minority of deals today get done with banks and other institutions without an intermediary running interference. Charles Krawitz, first vice president of Chicago-based LaSalle Bank's capital markets group, estimates that the bank places 90% of all its mortgages through originating brokers.
“Does a borrower need a broker?” Krawitz asked. “Most borrowers don't have the time or the inclination to stay abreast of the mortgage marketplace. A good mortgage broker knows every aspect of the market inside out and follows it as it changes week to week. Borrowers who think they can do it all themselves are doing themselves a real disservice in most cases.”
A crucial component
Lenders themselves have come to view brokers as a valuable asset. The best brokers oversee an early-stage screening process, rejecting inquiries up front that they know don't have a chance of getting financed. In fact, some firms say they toss away half the ideas they see.
“We get calls every day from people looking to do transactions who don't fit our parameters. We turn down lots of business. We tell the applicants to move on, and I suspect many never get a loan at all,” said Michael Melody, executive managing director of Houston-based L.J. Melody & Co, a mortgage brokerage firm.
“Five years ago, capital market sources were setting up direct-trading desks, and some people wondered whether there would be a place for brokers,” Melody added. “But since then the capital market firms have found that trying to do their own origination and screening is not very efficient. They've discovered that brokers can even be a very good source of underwriting due diligence. Mortgage brokers have come to be regarded as the go-to guys in the transaction process.”
A point of definition is in order. Plain old transaction-driven mortgage brokers were the norm in the industry at one time. Today most brokers have morphed into multi-faceted roles that include servicing loans and providing ongoing consulting services. Many now prefer the more august title of mortgage banker to describe themselves, although for the purposes of this article the designation of broker — still their central role — is retained.
The passing of the old, one-dimensional model has not exactly been mourned. “We have fewer curbstone salesmen out hawking low interest rates now,” Wineburgh said. “The business is becoming more professional all the time. I expect the pure brokers to continue disappearing.”
Making the right choice
Where should a borrower start in selecting the right broker? Geography. There are thousands of mortgage originators, but not all are created equal. Many run solo or small local operations, while others are part of networks of offices that stretch across the country. As lenders merge and become larger and developers take the same approach, many brokers are finding benefits in consolidation.
For example, Chicago-based iCap Realty Advisors LLC was hatched out of 11 regional firms that combined in February. The company expects to close on nearly $2.5 billion of business in its first full year. In the aggregate, volume is running 25% ahead of pre-merger levels.
“Most of the major owners and developers of real estate are branching out beyond their backyards. We decided we needed a national platform to service them,” said Ross A. Berman, president of iCap. “If a client of ours in Atlanta suddenly decides to do a deal in Boston, we can share information about the Boston market with our partnering office there. Lenders like that because they want to know that you aren't just doing a crash course in a city that you've never visited before. They like to deal with brokers who are entrenched in a market.”
Of course, there still is a place for the small operation. New borrowers seeking modest loans often complain that they're given scant attention at big brokerage houses. Their business is likely to be shunted to a twentysomething junior account executive, with senior members of the transaction team exercising oversight from afar.
In a small firm, it's more likely that the broker you meet and like on the first interview will stay with you through thick and thin until closing. For many borrowers, that's a great comfort.
Still, even the most ingratiating broker may not be able to find money for would-be borrowers in tough sectors such as hospitality right now. The sagging economy has forced borrowers to become realistic. “Hospitality was weak before the Sept. 11 tragedies and it's completely gone now,” said Michael Baucus, managing director of Chicago-based Cohen Financial. “You might need 50% or more equity to get a hotel deal done at this time. I'm advising hotel owners and developers to go to the sidelines for 90 to 180 days to see where occupancy rates stand. We may find out that this hospitality downturn is short-lived, and mortgages will become available again.”
Hotels aren't the only tough deals to pursue. The capital pipeline for unanchored retail strips has been drying up, although anchored retail remains relatively financeable. New office construction is anathema in many urban markets now, while acquisitions and refinancings are being scrutinized closely for tenant lease roll-overs and rent trends. Industrial has been more stable, while multifamily housing remains the favorite loan type for most institutions right now.
Borrowers should be sensitive to lenders' changing perceptions of markets, and even factor those perceptions into their own cash-flow calculations. In the face of low interest rates, Hines, a Houston-based office developer, has been encouraged recently to see lenders willing to make loans with a 65% loan-to-value ratio, up from 50% a year ago. But cash-flow assumptions by both lenders and buyers are turning dour.
“It used to be that a buyer of a property could count on holding onto 75% of office tenants during lease roll-overs,” said Hastings Johnson, CFO of Hines. “Now, the assumption is that you will lose as many as 50% of your tenants. Lenders are concerned about this trend.”
One of the first questions a broker should ask a client centers on an exit strategy: Do you intend to turn this property around and flip it in short order, or hold it for retirement income? Likewise, an alert borrower should not only be attentive to the answers he receives when interviewing a potential broker, but the borrower should also take stock of the questions the broker asks.
No broker can find the right loan match unless he has a firm understanding of the borrower's short- and long-term strategies. More and more brokerages are appending “advisory” to their corporate titles. For that to mean anything, there has to be effective two-way conversations.
In most cases, the price on the interest rate is what matters most to borrowers. It is here that a good broker really earns his or her fee. Dennis S. Bernard, president of Bernard Financial Group in Southfield, Mich., reports that when he puts a loan application out for auction he gets bids ranging from 225 to 260 basis points above the 10-year Treasury yield.
“Sometimes the spread in bids is 100 basis points,” Bernard said. “Certain lenders do certain product types better, and we know who they are. We can anticipate which institutions will be interested in certain kinds of loans and make sure they see your application. We save a client a lot of legwork in the process.”
Yet it isn't quite that simple. Borrowers ought to be wary of brokers who baldly promise that their mortgage applications will be shotgunned to 20 lenders or more. Better brokers realize that often a more targeted approach works better. Simon Ziff, president of New York-based Ackman-Ziff Real Estate Group LLC, sometimes will show an application to as few as two or three lenders and make it clear to them that they are part of a small bidding group, and that he wants their very best offers.
“By going with the people we know are likely to have the lowest prices, we can create a significant auction,” Ziff explained. “If you go to 20 lenders and everybody understands that they don't have a very good chance of landing the mortgage, they won't quote as aggressively. The last thing a broker wants to do is waste the time of lenders just to show a client he's working for them.”
Even in the best auction-like settings, borrowers reading about nosediving interest rates may be surprised when their broker informs them that they won't enjoy the full measure of the decline. Many lenders have imposed a floor on their commercial mortgages ranging between 6.75% and 7%, and no amount of jawboning by brokers is likely to budge them. The problem is that when the loan is packaged for resale as a commercial mortgage-backed security (CMBS), there is little institutional demand for anything carrying interest below a certain threshold.
However, “a really large transaction with low leverage and involving institutional-quality real estate might qualify for rates below the bottom of the market, perhaps 6.5% or so,” said J. Edward Blakey, senior managing director of Wells Fargo Bank in San Francisco. “Every transaction is different, and brokers are good at testing the limits of the market.”
Even so, borrowers shouldn't expect brokers to do the impossible. For example, Wells Fargo and most other banks hardly ever negotiate away yield-maintenance provisions. Pre-pay a mortgage, and you should expect to get stuck with penalties, as the bond market demands such restrictions. How big a penalty? If you have an 8% loan over 20 years, the penalty is designed to be big enough to give bondholders the 8% interest held all the way to maturity.
How much money?
What does the service of a good brokerage cost? Minneapolis-based NorthMarq Capital Inc. is probably typical. The firm charges a 1% fee on most mortgages under $10 million, and .5% on mortgages above $10 million, all tied to a sliding scale. Quality firms don't vary much from that range. Borrowers should beware of the low-ball outfit that promises miracles for a .25% fee. In most cases, the borrower will get what he paid for.
Similarly, interest-rate offers seemingly too good to be true often are. Experts say extremely attractive offers are most prone to “re-trading” at closing, a euphemism for an 11th-hour demand for renegotiation of price. Good brokers rarely experience re-trades because they ensure that the loans are structured within reasonable limits from the start. Smart borrowers ask brokers up front about the likelihood of re-trades.
Even if a broker won't reduce his own fee, and most rarely do, there are other savings in fees that he can negotiate. Brokers aren't above asking an appraiser to work at a fixed cost rather than at an hourly rate. Lawyers are sometimes asked by brokers to cap their fees for budget-conscious clients. The same goes for other professionals weighing in on the transaction.
The first-time client applying for a small loan might not be accorded such favors. “I'd be lying if I said the little guy doing a $2 million deal had as much clout as the big REIT in need of $100 million in financing,” said Edward Padilla, president and CEO of NorthMarq, who adds that small transactions can require as much staff work as large deals.
“And yet we'll still work hard for the $2 million transaction on the expectation that the borrower will come back to us next time with a bigger deal and will grow with us over time,” Padilla added.
Borrowers should not be shy about probing into the particulars of a broker's compensation and potential for conflict. For instance, a broker may service loans for 10 different lenders. Does that mean he will pitch your mortgage application first and foremost to just those 10 lenders?
Sometimes brokers get extra commissions, perhaps 20 basis points, for placing loans with certain favored lenders. Firms don't like to talk about such practices, but they exist even at places where so-called Chinese firewalls are designed to keep conflict between borrowers' and lenders' interests at bay. Borrowers are advised to take the offensive and ask blunt questions about exactly how their brokers earn their pay.
Some brokerages have such an array of products and services that it's hard to tell where conflict might begin and end. Cohen Financial in Chicago brokers mortgages and capital financings, arranges mezzanine debt and makes loans on its own balance sheet. It even consults. Yet the company is refreshingly candid about its versatility.
“Promote a deal to the overall market and you'll probably get better terms than what Cohen can give you,” said Baucus, the managing director of Cohen Financial. “We're a niche lender. People come to us because they believe we're more likely to close on time and deliver on the terms we promise than some other lenders. For that they're willing to pay a little more. Price is important, but so are reliability and loyalty.” Good brokers, Baucus adds, have those qualities in spades.
H. Lee Murphy is a Geneva, Ill-based writer.
Building a small fortune
Developer Gary Alcock swears by his mortgage broker, Chicago-based Cohen Financial, and it's no wonder. The firm has structured a couple of real estate deals for him that garnered a small fortune in profits.
A one-time property manager, Alcock dived into the investment business in 1996 with a $7 million acquisition of a 275,000 sq. ft. office building in Des Moines, Iowa. The tricky part was that Alcock only had $35,000 of his own money. Cohen found him a 75% loan-to-value mortgage from Tokyo-based Nomura Securities and then rustled up the other 25% in equity from an East Coast investment group.
Cohen touted the deal to both parties as a golden opportunity: Alcock was buying a building that generated $1.9 million per year in operating income at less than 20% of its approximate $35 million replacement cost.
There was a catch, as anchor tenant Equitable Cos. had served notice it intended to give up its space, potentially leaving the office tower half empty. But Alcock noted that the lease still had two years to run, and was confident he'd find new tenants in that time. He did, and though Equitable is long gone, the building has an occupancy rate of 94%.
The original equity partners were bought out after three years, and Alcock landed a new $12 million mortgage last year with Stamford, Conn.-based G.E. Capital that is locked in at a 7.94% interest rate. (Alcock declined to reveal the length of the mortgage.) Cohen even made sure that all of Alcock's debt was non-recourse, leaving his personal risk at almost nil.
“We've taken out a nice profit on the Des Moines building,” said the 38-year-old Alcock. He repeated the process in Peoria, Ill., recently, acquiring for $5.5 million a 270,000 sq. ft. building that generates $1.1 million in operating income per year. Almost all of the purchasing funds were borrowed. He expects to reap a $5 million profit by the time he sells out in a couple of years.
“I find something that is priced much less than it's worth, fix what's wrong and add value,” explained Alcock, who is based in Chicago. “Generally I look in secondary markets like Peoria and Des Moines. You can't find deals like mine in Chicago, where the real estate is picked over.”
Cohen has done yeoman's work for another client, Dallas-based AIC Ventures LP. On Aug. 20, Cohen helped arrange a $21 million sale-leaseback transaction in Houston involving a three-building corporate campus. AIC is in the hunt for other office and warehouse investment opportunities, with Cohen at the ready to arrange financing.
Peter Carlsen, president of AIC, once hopscotched from one mortgage broker to another. Not anymore. “There are too many problems in trying to piecemeal your business,” Carlsen said. “We've found that we get better service if we maintain a stable relationship with a single mortgage broker like Cohen. On a sticky deal, they're willing to jump through hoops for us. With a discounted brokerage fee you may save money in the short term, but you often don't get the best overall value for your project,” continued Carlsen. “With Cohen we're buying full-service support, and that's what matters most to us.”
— H. Lee Murphy