Private lenders may be well-positioned to help brokers find the upside of a down market

Kurt Lefteroff, principal, Secured Private Capital LLC

As published in Scotsman Guide's Commercial Edition, March 2009.

Although many commercial lenders have restricted their guidelines or stopped lending altogether, there still is one area of lending where brokers can help their investor borrowers find funds: private real estate lending.

Knowledgeable brokers can help their clients understand what factors indicate the top or bottom of the real estate market and why private-investor lenders may be their ideal funding source. With this understanding, your property-investor clients can come out on top when the market hits the bottom.

Understanding the cycle

The real estate cycle tends to follow the business cycle, which depends on economic growth.

More jobs means more space -- i.e., offices, warehouses, factories, shops, etc. -- is needed for workers. More workers means more housing is needed. And more housing means more shopping centers are needed for new neighborhoods. When there are job losses and higher unemployment rates, on the other hand, these things suffer.

Each property type has its green-light signal for growth. For offices, for example, that signal is a market vacancy of less than 10 percent. This means that tenants looking for space have fewer options, and the pricing power returns to the landlords. Developers thus start building new office buildings. The early-bird developers fare well, while developers late to the party suffer as tenant demand subsides, either through overbuilding or a turn in the economic cycle.

Top to bottom

Some investors miss the signs that a market is topping off or convince themselves that it's different from before. By the time these investors recognize that they are in trouble, it may already be too late.

There are several key indicators that the real estate market is reaching the top. The first is a shift in the supply-demand dynamic. Either too much new space is on the market, causing excess supply, or tenants delay expansion plans or reduce space leased, resulting in reduced demand.

The pricing power returns then to the tenants, and landlords suffer. Generally, when it comes to pricing power, seven out of 10 years favor the tenant over the landlord anyway. Landlords increase rent concessions first in the denial phase, and they later drop rents in the capitulation phase.

Another good indicator would be whether the average person -- your barber or hairdresser, for example -- is conversant in commercial real estate trends. When that happens, it is probably time to get out.

For example, in March 2006, a friend and I overhead a presentation that one fellow was enthusiastically making to two others in a restaurant about how easy it was to flip houses. He said, "You can't afford not to buy."

I sized up the speaker as a novice and told my friend that we had just witnessed the top of the housing market.

The private world

So just where are we in the cycle? I don't think we are at the bottom yet. There is still time to play defense.

For clients who have equity funds to invest in commercial real estate, it may be a good idea to stay on the sidelines for a while. Good investments are hard to find and even harder to buy.

But for those of your clients who wish to buy now, funding options still exist. Even when most conventional lenders are limiting the loans they make or pulling out of the market altogether, private-money lenders still are finding success in this climate.

They make calculated, secured loans on investment-grade real estate and make highly predictable, double-digit returns.

Given the focus on safety and valuation, brokering private loans is not for novices. All the advantages of a private loan fail if the broker turns to a lender that does not understand local-market conditions and the underlying collateral's value in a variety of potential future scenarios.

Kurt Lefteroff is a principal of Secured Private Capital LLC, a direct-portfolio private lender located in Scottsdale, Ariz. Reach him at kurt@securedcap.com or (480) 315-1515. Visit the company's Web site at www.securedcap.com.