Foreign lenders active, but strict - foreign real estate investors have high lending standards; previously published in Chain Store Age - Finance

Real Estate Weekly, May 20, 1992 by Stephen J. Pearlman

Foreign investment in U.S. real estate was significant in the 1980's. Foreign capital was invested here because of the overall economic stability of the US economy and the greater opportunities for economic gain. In the 1990's, because of our economic recession and the disappearance of domestic financing sources, foreign investment capital has become more crucial than ever before in filling the void created by the absence of U.S. investors in the real estate market. Japanese capital is not coming into the United States as it was during the 1980's. Now the largest quantities of foreign capital for investment in U.S. real estate today are coming from European institutions --- German, Dutch, Swedish and British -- as well as from small pockets of "entrepreneurial" capital located in the Far East, predominantly Southeast Asia. Foreign investment, especially from Europe, comes from public pension funds and lending institutions. It is important to understand the investment objectives and structures which these investors utilize. They are usually in the forms of direct investments, convertible and participating financings, as well as traditional real estate financings such as construction and mini permanent loans.

Foreign banks in the market today are very clear about their lending standards. Having the historical perspective of watching the influx of foreign bank lending in the early 1980's -- which had fairly lenient underwriting criteria -- today's foreign lenders underwrite to very conservative standards. In construction lending, French, German and British banks, for example, are making construction loans available but with high credit standards and expensive pricing. For example, to obtain a construction loan for a new retail shopping center, a developer needs: * A strong financial profile * The injection of real equity into the project- minimum 30 percent * A project possessing a good market location and the right demographics, anchor tenants * Signed pre-leases in place; no exit clauses * To source a secondary lender to perform a bona fide take-out if necessary.

With all of these criteria in place, the foreign lender will get 200 to 250 basis points spread over LIBOR (London Interbank Offering Rate) and most probably at least a I percent financing fee. This is a far cry from the foreign lenders in the mid 1980's who were taking substantial market and credit risk and only getting 60 to 100 basis points spread over LIBOR.

Recently, Jones Lang Wootton structured one of the only retail construction loans in 1991 -- the financing for 840 North Michigan Avenue, a 86,000 square foot retail property in Chicago. The developer was US Equities Realty Inc. The financing was truly an international one with participating banks from Germany, Great Britain and France. The banks recognized the value of the property on Michigan Avenue as one of the most prestigious shopping locations in the world and they also were comfortable with the credit of the two anchor tenants-FAO Schwarz and ESCADA. This was definitely an opportunity grasped by international capital sources.

Foreign lenders are motivated to enter the U.S. market both because loans are more easily accessible and higher spreads are available. Also, most foreign capital follows its national clients who do business in the United States. The forms of capital investment used here include convertible and participating debt. In the 1980's, the Japanese institutions utilized the convertible mortgage as a form of investment. The foreign investor could make a loan secured by a mortgage for 5 to 10 years with a conversion option which could allow, at some point in time, some or all of the debt to be converted to equity.

Participating mortgages have recently become a very expedient way for foreign capital to invest in U.S. real estate. The lender has the safety of a mortgage, albeit subordinated to a first mortgage, and can get higher returns as well as equity kickers. JLW, working with a large Middle Eastern bank, has put together a fund to make participating loans on U.S. properties. The primary target is participating second mortgages on selected leased properties with some emphasis on investment grade small shopping centers and multi family residential projects.

Non-U.S. financing of real estate has taken on a different perspective in the 1990's. More equity is required in the projects from the investors point of view. The foreign capital source today wants better returns on its investment and is looking only at quality projects. The United States remains a good place for foreign investment and, with the real estate recession hopefully bottoming out soon, we can expect to attract more foreign capital in the future.