Jason Hernandez, Managing Director, Head of Debt Originations for Nuveen Real Estate, speaks about the structure of office loans and the most important factors in deciding to make these loans.
Q: In today's lending climate, what are the most important factors you consider when deciding whether to make an office loan?
A: With the exception of retail and hospitality, office has the most headwinds. In today's environment, there are few office trades, making it difficult to determine valuation, and there is also a lack of leasing activity, making it difficult to predict future revenue streams.
We initially saw opportunities in industrial and multifamily, but pricing in those markets quickly rebounded, so now we're seeing better relative value in office. Offices located in a central business district with density and public transit issues present a challenge given the pandemic, so we've turned our attention in the short-term to what we call "urban/suburban" or "drive to" office locations. For example, markets like Atlanta or Nashville with "drive to" office buildings comprising 6 to 10-stories versus CBD office towers. Lending in the office space is good relative value compared to what we see in the industrial and multifamily space.
Q: What type of structure do you require for these loans?
A: We focus on shorter two-, three- and five-year loan terms. Given the combination of historically low interest rates and the general uncertainty regarding how things will look post-COVID, we think shorter duration is a better trade than going long.
In today's market, we know there are economic headwinds, and we are looking at what happened during the 2008-09 financial crisis for guidance. We are underwriting flat or negative rent growth and low occupancy rates over the next 24 to 30 months as people slowly return to the office.
Regarding valuation, we are in a low-yield environment and don't expect cap rates to expand nationwide in the near term. Considering all of this, we are underwriting values today on office deals anywhere from 5-15 percent below pre-COVID values.
Also, we're lending on a reset basis with lower advance rates. Our target loan-to-cost is 65-70 percent as opposed to 70-75 percent pre-COVID. We are able to achieve better terms on cash management, and there's a greater focus on a borrower's business plan with loan extensions being conditioned on the property achieving certain economic milestones.
Q: Where are you seeing opportunities today? Are you willing to lend on retail assets?
A: We do short-term floating-rate loans and long-term fixed-rate loans. As far as long-term fixed-rate loans, we're predominantly lending on industrial.
For multifamily, we believe that we can compete with GSEs on pre-stabilized multifamily product and are providing both short and long-term loan options. For example, refinancing an existing construction loan on a multifamily property that is 50 percent leased into either a long-term fixed-rate loan with a resizing component in the event the property doesn't stabilize within a given period or a short-term floating-rate loan to allow the sponsor to get off the recourse of their construction loan and realize some equity in the project.
As far as retail, we are being highly selective and could see opportunities in the grocery anchored or needs-based retail segments.
Q: How much of your day do you spend on new loan origination versus asset management?
A: In April and May, it was 70 percent asset management and 30 percent loan origination. Today it's likely 75 percent loan origination and 25 percent asset management.
We're at the point now where initial forbearance periods are starting to burn off, and we're trying to figure how the second round of forbearance will look, if necessary.
Q: How much hotel exposure do you have?
A: We have limited hospitality exposure, and because of where we were in the cycle, we decided to target limited-service hotels with better margins than full-service hotels. And an added benefit of lending on limited-service hotels is that they tend to recover faster than full-service hotels. So net-net, we have limited exposure and what we do have, we feel good about the limited service nature.