PACE inside baseball: Private-label securities to the rescue?

GSE’s bench PACE

If you follow the PACE saga — which we covered in February’s Pacesetter as well as in numerous posts before, you know that it’s attracted enough interest to keep us all hopeful about the prospects for a liquid secondary market for energy efficiency loans.

But, like any saga, there are always curveballs and intrigue to keep us wondering.

GSE’s (government-sponsored entities) Fannie Mae and Freddie Mac supplied the  action in this latest edition of PACEwatch.

They recently sent PACE financing back to the dugout, by declining the purchase of tax-lien secured energy efficiency loans on residential properties, citing concerns with repayment risk associated with the priority of the tax-lien over the senior mortgages.

No, folks,  the tax-lien-priority issue will not just get up and walk away on it’s own.  Market watchers quoted in the article point out that pricing in the theoretical risk and/or clearer underwriting to clarify the value improvements to the retrofitted properties could help the GSE’s and others buy into PACE-related debt.

IMHO, it’s going to take a solid mix of both approaches to get the secondary market comfortable with fund PACE paper.  Altering a senior mortgage’s status makes it tougher for the lender to price and re-sell their loans, even if retrofits improve property valuation. They’ll want compensation for what could be an important change to their contractual structure. It’s always been that way with modifications and I don’t think there’s anything wrong with a lender expecting to be paid a market return for agreeing to re-do a deal.

Additionally, requests to see, touch and feel (and standardize) the control of the retrofit value-creation process, beyond the theoretical math of energy savings is reasonable. Programs that dole out tax payer dollars without robust underwriting and performance measurement are setting themselves up for failure.  No matter how smart we become every economic cycle, a certain percentage of loans typically fail for the same old reasons.  “Failure to properly monitor” loans is one of the oldest, and most typical paths to default.

So, while I greatly wish to see lots more capital flowing towards PACE financing, I still think it’s prudent for any lender to request clarity on the loans they buy and to be paid the right price for the risk and underwriting.

Inside baseball: private-label securitizations to the rescue?

That being said, I suggest we keep our collective eyes on the private-label securities market as an alternative funding source.  Yeah, I know it’s been dead since the economic downturn, but that would be the alternative for PACE to build up a liquid secondary market as long as the GSE’s aren’t stepping up to buy energy loans.

And the idea’s not so far-fetched since the private-label market is now starting to show signs of life.  While the GSE’s are definitely big players in the residential mortgage secondary market, which reached $2 trillion at it’s height in 2006, private-label securities were responsible for as much as 56% of home mortgage securitizations during the same time frame.

Today’s WSJ details how Redwood Trust is taking a shot at offering ~$200 million in jumbo residential mortgages in a private-label sale. This will be the first sale of private-label mortgages in two years. Market watchers say that the timing seems good for private-label securitizations to make a comeback, now that the homeowner default surge that killed the market a couple of years ago has receded. Add to that, the currently tight underwriting guidelines in effect, which strengthens the credit quality of these loans, making them attractive to secondary market investors.

Note that this particular transaction is not a done deal yet, and Redwood may have to postpone the transaction if they can’t generate sufficient interest in the offering.

For us PACE fans, however, this is bit of side action is worth tracking. The private-label securitization market is another potential source of secondary market liquidity, if the GSE’s continue to reject energy efficiency finance.

I’m willing to bet, however, that private-label market will be just as tough on conforming documentation and tight underwriting guidelines. If investors are now able to buy into residential mortgage paper structured  with tight underwriting and and high credit quality, what will compel them to give that up for PACE-paper?

Nothing, I think.

Nonetheless, the game is not over and we’ve still got several more innings to go.

Our (2007-2008) Green Journey - 9 Ways Green Building is Revolutionizing Commercial Real Estate

Happy New Year from Berlin’s Prenzlberg! The former East Germany is a great place to reflect on transformation and my usual year end questions are “how is my life different now than a year ago?”, and “where should I focus my attention in the coming year?”. The Green Journey approach to understanding green real estate finance and investment trends is not much different:

• What changes in real estate and green building are making us talk and act differently now as opposed to a year ago?
  

• What issues will shape what we say and do about green real estate  in 2008

2007 - The Sustainability Revolution

9 Building green is now a requirement, not an option.
At the end of 2006, green building was a futuristic concept - not a critical component of value creation. Now that is over:

• Studies from Davis, Langdon and United Technologies show the cost of building green can be comparable to non-green buildings, making the benefits of green building accessible to every real estate owner.
• We also covered industry pacesetters, such as Digital Realty Trust and GE Real Estate, who are already out of the gate with investment strategies centered on building, acquiring and greening their assets.
• Going green became a cool investment move recommended by mainstream economists by the end of 2007, making it clear that green is also competitive and profitable.

8 Uncontrolled and undisclosed carbon emissions are a legal and economic risk.
Aggressive legal and regulatory action kicked up some dust in 2007, showing that cities and states are regulating Corporate America’s carbon emissions, regardless of the political winds at the federal level. As one fund manager put it, “[carbon emissions regulation] is not a question of if, but when“.

• Real estate investors should check out Post Carbon Cities and pay special attention to the advice being given to municipalities on aligning local zoning and land use policy with sustainability and climate change goals.
• We posted before about the evolving requirement of disclosure of material risks associated with climate change and greenhouse gas emissions to shareholders.

7 Green financial pilot projects make first spflutters
While the credit markets went sideways on us, that didn’t stop some forward thinking groups from taking on the challenge of accelerating capital flows to green real estate. Nothing tangible is out of the gate, yet, but they still deserve our praise and attention.

• We posted about Sustainable Capital’s green residential mortgage backed securities platform, Green Bonds as well as the Clinton Climate Exchange’s $5 billion kick start of the building retrofit finance market. Expect a vigilant birddogging of these initiatives, since increased capital flows to green building is the critical validation needed for further expansion of sustainability.

6 National credit crunch =  Has anybody seen my lender?
Unfortunately, for a lot of the banks, “the beatings will continue until morale improves”. The latest post from The Real Estate Bloggers says it all. The silver lining for green building? Capital markets volatility forced us to hit the ‘pause’ button on business as usual dealmaking. Survival in ‘08 requires excellence at old school fundamentals: operations, tenant retention, and value creation. We posted about whether “subprime was good for green real estate?” with the answer that ‘cash is king’, meaning that green real estate is in a better position to generate more cash flow.

2008 - ‘The [Sustainability] Revolution Will Be Standardized’

5 Institutional Investors: Insufficient green product & at what price?
Constrained Debt has a cousin named Lotta Equity and she has a couple of frustrating problems — there’s not enough green projects out there to buy and no one has figured out how much to pay for it. A colleague forwarded a great article from the San Jose Mercury News, where a RREEF’s Andrew Nelson outlined the dilemmas:

“There just isn’t much green real estate to buy, making it tough to determine the value of green… “All the initial construction was owned and built for governments and you can’t turn around and sell that, so there has been very few - almost no transactions of green buildings,” he said. “When investors think about the business case for green buildings, they want to know: How do they sell? The answer is we don’t know.”

4 The Rise of Sustainable Markets: Know your city’s climate change, resource and energy agenda

With our post on San Jose, we considered cities that use sustainability to compete for talent, investment and to maintain long term viability. They have become sustainability’s cowboys, driving their own resource, energy and climate change policies, since the federal government can not deliver a comprehensive enough solution that preserves their viability. Since real estate has been outed as the big consumer of city resources and energy services and the big contributer to regional carbon output, it is fair to say that investors will have to think about investment markets in terms of resource and energy sustainability in addition to classic real estate fundamentals so that they can remain relevant to their municipal partners. Check out the U.S. Conference of Mayors website where you’ll see the cities strut their stuff on resource, energy and climate change.

3 Real Estate Innovations: Compete using adaptive reuse and explore overlooked construction methods

We posted here about moving beyond simply building brand new LEED-certified buildings. Eeking out profits from existing real estate and focusing on other construction methods must since the cost side of new construction is not expected to decrease ever. Check out these two posts as food for thought:

• Dave Stejkowski, aka The Dirt Attorney, blogged about a compelling Economist story on lifestyle centers. Nothing for me to add here. Read the post and the article for the full picture.
• Howard Liggett posted about ‘The Myths of Modular Housing’ - a lower cost building method long in use in Germany and other countries, but still stigmatized and misunderstood in the United States.

2 LEED & Beyond: We need transparent performance assessment of building performance

We stay abreast of the EU’s moves on greenhouse gas and energy policy to understand the various ways green buildings are being adopted. And we concluded that ‘transparency makes a market’. No particular rating system in and of itself completely informs an investor about the true performance of a green building. In addition to increasing the certification of green buildings, there will have to be a focus on establishing transparent disclosure of the actual performance being achieved by green buildings, to remove the risk of investors and tenants overpaying for substandard green buildings in the coming years.

1 Land use policy is the new civil rights movement.

I was at a recent function where an executive said “Land use is what will change our children’s future”. His position was that we overfocus on individual green projects, forgetting that the greatest impact on a development happens within zoning and land use planning forums, since this is where decisions on use, infrastructure, transit, density, energy and resource use are made. And these decisions determine the quality of life and livelihood of ordinary citizens and businesses for generations. Sustainability as a movement is changing our individual assumptions about fairness, rights and responsibilities at every level of society. Local officials and citizens are now more vocal about the fair allocation and continued provision of resources and energy as a part of their basic rights  — and are becoming increasingly active in shaping land use decisions to defend those interests. Real estate investors are already very familiar with land use and environmental issues in general, but the growing notion of citizens perceiving resources and energy access as part of their moral rights is an additional level of complexity that sustainability brings to the land use planning. Read ULI’s The Ground Floor to keep abreast of the (r)evolution of sustainability within land use policy.

* * *

I think a nine point countdown is enough for a year - plus we can never be sure what else is around the corner. If you have any more burning issues that you think we should be covering, please drop us a line! We would love to hear your thoughts and perhaps share your contributions the rest of the Green Journey crowd.

So much success in in 2008 and we hope for an exciting year in green real estate!

Photo credit: flickr/inky Bob - Compass and Map Mono

ULI 2008 Fortune Telling: A Shortlist of Cool Moves Including Going Green

“Two years from now, a Class A non-green building will not be considered Class A.”

- George Denise, General Manager for Cushman Wakefield /Adobe Systems San Jose Campus. Overheard during a panel session on green building.

Like a lot of finance professionals, I was hopeful about attending the ULI Emerging Trends 2008 conference here in San Francisco — welcoming any port in the credit market storm. Added to that was the promise of a big discussion on green real estate for the first time by one of the mainstream real estate economists.

So let’s cut to the chase: now the message is that there will be an overall slowing of the economy (sigh…duh), investors are crossing their fingers in hope that consumer demand will remain at acceptable levels, and that interest rates do not become too much of a wild card. In short, Joe or Jane Q. Investor will have to surf choppy waters for awhile but in the end, should come out in good shape.

And they stress that current conditions seem right for making a few cool moves. Here is the ULI shortlist:

• Have Dry Powder (Or Go Get Some): Investors with strong relationships and liquidity are going to score now that there may be more motivated, overleveraged sellers in the market needing a lifeline.
• Buy Distressed Loans: Investors are looking at B and mezz loans, figuring that they can get their hands on a quality asset for a 10%-20% discount from its original value if the borrower is unable to repay the obligation.
• Focus on Global Pathway Markets: Traditional 24-hour megacities enjoy more buyer demand and upside potential, especially when capital gets nervous.
• Buy Public REITS: A panelist from BRE Properties, Inc., a top multifamily player, gave a great analysis of the value. Their high quality multifamily portfolio is valued at an implied cap rate of 6.8%, yet multifamily is expected to outperform other asset classes. Cap rates for Class A multifamily shouldn’t get too far above 6%! In the case of multifamily, many stock analysts lump them together with other residential stocks, like homebuilders, so they’ve been taking a harder beating than is really justified by their asset quality and performance.
• Use Demographic Strategies: Old school dirt investors like myself love this category, because it plays to our strength of intimately knowing communities and their potential. Seniors housing, second homes, medical office buildings, and even student housing play on baby boomer wealth accumulation and long lifespans. Also think about urban plays that penetrate markets with high immigrant inflows.

The Green Competition Factor

Green real estate was woven into the conference as a prominent economic factor affecting the direction of investment real estate in many ways. The economists explicitly cautioned that owners of non-green buildings in high development markets should start understanding the impact of new green developments being built around their properties. In short, the presence of green developments around brown real estate may decrease the competitiveness of brown real estate. The lead in quote to this post, from George Denise, of Cushman Wakefield, is his point of view. I would add that two years ago no one would have even understood what he was saying and now people might start to realize that his point is highly plausible.

Green Real Estate Plays for 2008

ULI’s take on busting a move with green real estate was still restricted to thinking about new development plays — so they still have a ways to go in my book. Also note that ULI didn’t delve into any discussion of defining green, which is appropriate for an economics-oriented conference. And here’s a couple of their recommended green plays for 2008:

Green equals competitive advantage: Okay, for the Green Journey crowd, this is preaching to the choir. But believe it or not, just thinking about building green at all is still pretty edgy for alot of market investors.

• Focus on Mixed Use and Infill: 24-hour residential environments with pedestrian-friendly layouts and varied living options are in. Particularly among empty nesters and career starters. Fringe subdivisions without amenities are losing appeal.

• Build Transit-Oriented Development: Condominiums, apartments and retail near lightrail or subway/train stops are becoming “increasingly attractive”.

Green Journey Takeaways

ULI did do a good job of evangelizing green from an economic point of view and started the process of translating green into an investment strategy — critical for market transformation of our industry.

I’m still waiting for one of the big firms to be a leader in discussing how we green existing buildings.

Photocredit: Flickr/Jai-to-Z

Extinct Debt Terms & Agency Muscle in Multifamily

Here’s a quick update on the pulse of the debt market:

Earlier this week, I had the great pleasure of spending time with colleagues at the Counselors of Real Estate at their annual convention here in San Francisco. During a Capital Markets forum, the panel was asked their views about the types of deals lenders are willing to do these days, in light of the currently constrained credit markets. That discussion humorously morphed into “what kinds of debt terms are extinct these days”.

So here are a couple of the debt market’s newest extinct species:

• Full Term I/O: Lots of nods on this one — wide agreement that lenders are back to old school underwriting, requiring at least 25 to 30 year amortization for most loan terms over three years. On a 5+ year loan, the borrower may be able to get up to two years I/O.
• Cashout Refi: In light of rates, spreads and cap rates having moved up, creating the risk of lowered valuations, lenders are particularly hard-pressed to finance profit-taking anymore.

Plus a Snippet on Apartment Financing

There was a strong consensus that the agencies (Fannie Mae, Freddie Mac) are emerging as true winners in financing apartments during the debt market’s latest gyrations. They are putting out large levels of debt for apartments, using their own underwriting criteria and benefitting from less competition. The audience felt that the strong presence of the agencies makes the multifamily market the strongest asset class out there for now.

While this blog is heavily focused on green real estate, I like to bring in capital markets commentary since green real estate, after all, is still real estate.

The Lender Case for Going Green

I had a good time this afternoon with the USGBC Chapter BayLUG (Bay Area LEED User Group), along with Chris Bartle of Green Key Real Estate. I gave a banker’s perspective on green commercial real estate and Chris shared his expertise on the situation for green residential. My synopsis on financing green commercial real estate:

• Many real estate deals are sidelined now due to current capital market conditions

• The positive business case for going green is being heard by financial institutions. I receive a strong, constant flow of positive anecdotal evidence that green buildings deliver superior economic performance.

• Financing green buildings is hampered by poor integration of the players.

• While an investment in a green building creates much additional value overall, there is an uneven allocation of that economic upside among the different players — lenders are not seeing a tangible (read: cash) value-add for financing green, and so have been sluggish to establish green lending programs.

• More organizational and industry paradigm shifts are on the way as green buildings emerge as a preferred investment asset for institutional real estate.

How to move forward? As they say in Cameroon,

The questioner never loses the way…

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