Financing Focus

Financing Still Available for Well- Structured Technology Ventures

Less than a year ago, landlords and lenders were trading warrants for security deposits and leasing space at exorbitant rents to technology tenants. Currently, with the Nasdaq below 2000 and capital spending for technology at a halt, corporate credit has weakened dramatically. This not only has affected dot-coms, but also blue-chip technology firms and traditional bricks-and-mortar companies. The maturing real estate cycle is compounding weakened tenant credit and further limiting rents and valuations, and, as a result, capital markets are becoming more conservative with respect to technology-oriented projects.

However, technology projects still can obtain financing under the right circumstances. Banks, life insurance companies, and commercial mortgage-backed securities lenders are considering these opportunities, but their appetites are limited. Leverage for typical deals is being capped at 70 percent loan-to-value ratios with 20-year to 25-year amortization schedules. Strong debt service coverage ratios in excess of 1.30 are required because excess cash flow often is needed to fund re-tenanting escrows. While banks and CMBS lenders may structure more leverage or cash flow to property owners, they may require personal recourses and structures such as lock boxes, hyper-amortization, and cash flow sweeps for re-tenanting costs. Although loan terms have changed, pricing has remained somewhat attractive at 230 to 275 basis point spreads over U.S. Treasuries.

Loan terms and structuring provide the framework for financing tech-oriented deals. However, a tenant's credit still must be solid. Dot-coms have little chance of obtaining financing in this market, except for a handful of well-established companies such as Yahoo! and e-Bay, as flawed business plans and weak financials create risks no lender will take. Financing for technology projects is being steered toward owners with blue-chip tech tenants such as Cisco Systems, Applied Materials, and Agilent Technologies.

Requirements for Financing Tech tenants must have positive, free cash flow from operations to obtain financing. A year ago lenders financed tenants with two or more years of burn rate; however, today lenders won't quote loans if tenants aren't making money from operations.

The likelihood of obtaining financing increases if a tenant's industry track record demonstrates a solid business plan and sustainability throughout market cycles. And tenants must have enough cash on their balance sheets to weather the economic storm. As equity markets have shut down and venture capital firms have diversified investments in other industries, tenants who don't have a significant amount of cash probably won't survive.

U.S. Markets Most lenders still will consider financing in any U.S. market, but several are drawing greater scrutiny. San Francisco/Silicon Valley, Boston, and Austin, Texas, are three examples of markets where lenders are being more cautious.

In San Francisco's South of Market district, developers have converted dozens of industrial buildings and obsolete office structures into office space to house technology tenants. In Boston, the Interstate-495 market resurged due to technology growth resulting in older office and manufacturing buildings being expanded and reskinned. Austin has experienced significant new construction, and although the space was absorbed, much of it is returning to the market through subleases or tenant defaults.

In the Boston I-495 market, vacancy rates have risen from 3 percent in September 2000 to more than 10 percent currently. Because this availability has not yet stabilized, many lenders, particularly portfolio lenders, have limited appetites in these boom-or-bust markets. In all cases, lenders will be very conservative in estimating vacancy rates, which further limits financing opportunities.

Strategies for Brokers and Owners To make deals more attractive to lenders, brokers and owners should consider a number of strategies.

Negotiate Long-Term Leases or Consider Short-Term Loans. Lenders prefer to lend on lease terms that exceed loan maturity. If a lender believes in the long-term viability of a tenant, a hyper-amortization structure may be used. If the loan is not repaid by its anticipated maturity date, hyper-amortization allows all excess cash flow from the property to pay down the principal of the loan.

Offer Cash Flow Sweeps. Lenders are very concerned with principal exposure at loan maturity or lease expiration. By providing for all excess cash flow to be escrowed during a tenant's notice period before expiration or 12 to 18 months before maturity, the lender's principal exposure is mitigated while the borrower maintains cash flow during the majority of the loan term.

Shorten Amortization Length. In lieu of cash flow sweeps and hyper-amortization, 15-year and 20-year amortization schedules provide the same result as mitigating principal exposure at refinance.

Request Larger Security Deposits. Structure leases with significant security deposits; even 12 months of rent is too little for many tenants. Lenders now are requiring security deposits or re-tenanting reserves that can cover rent and reimbursements for downtime between leases, plus costs to cover leasing commissions and ample tenant improvements. In most cases these costs equate to 18 months to 24 months of a tenant's rent.

Put More Equity in Deals. Today's market conditions have prompted lenders to lend on lower-leverage deals at less pricing rather than getting an extra 5 percent of loan proceeds. At minimum, 30 percent equity starts to attract lenders; however, the lower the leverage, the more attention and consideration deals will receive.

Concentrate on Credit. Despite the economic downturn and examples of previously strong companies such as Lucent and Xerox that now are on the verge of failure, some lenders will underwrite an investment-grade tenant aggressively. Deals that are single-tenant or predominantly leased to one tenant can attract credit tenant lease lenders who will size and price such transactions more attractively than real estate-oriented lenders.

Highlight Below-Market Rent Situations. Lenders prefer deals in which the tenant is paying below-market rent. From a lender's perspective, rents 75 percent or less of sustainable market rates offer a competitive re-leasing advantage in weak markets. If a tenant defaults, owners quickly can release the space at a below-market rent and still support the loan's debt service. Because the loan was underwritten on a below-market rent structure, it has the ability to continue to perform if market rents decrease.

As plenty of capital remains in the market, technology-oriented deals will continue to be financed. For commercial real estate brokers and owners the returns may not be the same, but liquidity exists for the well-structured deal.

Benjamin S. Nummy

Benjamin S. Nummy is a vice president in the New York office of Morgan Stanley. Contact him at (212) 761-4504 or


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