The Deals Getting Done Today: Four Snapshots of Real Transactions
Some deals are still happening in today's environment. Here's what they have in common.
Today’s Thesis Driven letter is a collaboration with Eric Brody, founder and principal at ANAX Real Estate Partners. ANAX is a strategic advisor and capital allocator based in New York City. Eric is also the host of the Real Tech Talk podcast.
Conventional wisdom holds that the real estate industry is frozen; the rapid rise in rates over the past 18 months have carved a gulf between buyers and sellers. But while deal velocity has surely slowed, it has not entirely come to a standstill.
We’ve assembled four vignettes of actual real estate deals getting done this month. For each, we include the relevant details that brought the buyer and seller (or sponsor and investor) to terms, including rates and prices where relevant. All four deals are real but anonymized.
From there, we’ll look at the shared characteristics of deals that are getting done today and some thoughts on how real estate GPs and investors can approach today’s challenging market.
Deal #1: Recapitalization of a Stalled Multifamily Project
The background: A large mixed-use multifamily project in the northeastern US ran out of capital before reaching completion due to a combination of construction delays and interest rate escalation. The project is approximately 90% complete, with 3-6 months of construction remaining. The existing lender is demanding to be bought out, so $125 million of fresh capital is required to push the project over the finish line and take it through stabilization.
The deal: A debt fund is bringing $95 million of senior debt at SOFR plus 8%. The debt fund will also inject $15 million of preferred equity in exchange for 50% of the deal-level profit after the loan is repaid. The existing developer will raise and invest an additional $15 million of equity to round out the capitalization.
The existing equity for the project is wiped out, but the developer accepts a “hope note” giving them a chance to earn some return in the future if the project is a success.
Why it got done: Together, the debt fund and the developer believe that the exit value will exceed the new capitalization and the project will be a success at this reset value. The developer is willing to take the pain today in exchange for getting the project over the finish line.
Deal #2: Spec office in the Southeast
The background: An office developer formed a joint venture with a landowner to develop a Class A spec office tower in a major urban center in the southeastern US. The total development cost is $100 million, of which the developer is looking to finance $70m with a construction loan.
The deal: Together, the developer and the landowner funded the equity with $30 million in cash. Given the weakness of the office market, the developer initially struggled to find a construction loan. But after pre-leasing 50% of the property at strong rents, the developer was able to draw interest from a lender willing to put in $70 million at SOFR plus 7%.
Why it got done: One, the sponsors put in the work—and cash—to make the deal happen. Two, office demand hasn’t entirely disappeared; leases are still getting signed for amenitized, Class A office product. Since the sponsors were able to demonstrate early success by pre-leasing almost half of the yet-to-be-constructed building—a considerable feat—they were able to get the deal done.
Deal #3: Northeast condo project
The background: A developer is in contract on a development site for a ground-up Type I condo project in a northeastern US market with little new condo supply in the pipeline. The total development cost is $400 million.
The deal: Knowing that fundraising will take time, the developer inked a long (12 month) diligence period with the seller of the site. This gave the developer enough time to raise $100 million of equity as well as receive all necessary approvals and entitlements. Finally, the developer was able to line up $300 million in financing from a debt fund at SOFR plus 6.5%.
Why it got done: This developer–who has a strong track record in the market–gave themselves enough runway with the seller of the site to line up all the pieces needed to get the deal done. The lack of supply coming online in the market gave investors’ confidence in the project’s underwriting and projected pricing.
Deal #4: Resort / Single-Family Inventory Loan
The background: A US developer recently completed a resort project–including an 18-hole golf course–in the southeastern US with a number of 0.5-acre for-sale homesites. While the existing construction loan is coming due, the developer is seeing good absorption and would rather not be forced to cut homesite prices to pay off the project loan.
The deal: After receiving multiple offers from lenders, the developer closed on a $22 million inventory loan from a debt fund charging 12% over 12 months. They used the proceeds of this loan to pay off their construction financing and were able to continue selling homesites at their desired pace.
Why it got done: First and foremost, the fundamentals here are good: there is still strong demand for what new-build single-family homes are available in the market despite higher rates, and the developer was able to demonstrate this with strong initial sales. By taking a senior secured position in this development, the inventory lender’s downside was limited.
Shared Traits of Deals Happening Today
While each deal is unique, the deals that are getting done today share a few characteristics that make them viable.
Recognition of the current environment
The real estate deal environment has fundamentally changed over the past 18 months; prices have shifted and the deals that got done in 2021 simply aren’t happening today. The single biggest unifying trait across all deals getting done right now is recognition of that change and willingness by sellers and developers alike to accept today’s realities.
For land sellers, this often means accepting both a reduced price and a longer contract period with more contingencies (more on that in a bit). For developers, it means accepting higher rates, higher hurdles, and a tighter leash from lenders and LPs alike.
While some deals involve distress—and one side of the table’s hand being forced—they don’t have to. Equity and debt capital is still available, even if it is more expensive and comes at worse terms than it did two years ago. For many sponsors, it is better to realize losses and accept a hope note than it is to lose an asset entirely.
Getting new lenders to the mid-teens (or beyond)
As shown in the four deals detailed above, the profile of lenders in the market has changed dramatically over the past 18 months. Traditional banks have pulled back, retreating from construction lending under a combination of regulatory and financial pressure. But that doesn’t mean that construction lending has disappeared. Instead, debt funds have emerged to take the place of more traditional lenders.
Unfortunately, debt funds can’t justify doing deals at IRRs in the low teens like traditional banks can. Instead, debt funds in most markets are looking to underwrite deal-level returns in the mid (or even high) teens.
In many cases, lenders are achieving these returns by investing across multiple parts of the capital stack: specifically, preferred equity as well as senior debt. By blending the risk / return profiles of preferred equity and senior debt, debt funds are able to achieve their return targets while maintaining some protection in the capital stack. Sponsors, on the other hand, must be comfortable giving up a bigger chunk of the pie.
Demonstrated progress or success
The bar for convincing an equity investor or lender has risen; the projects that are getting funded are either:
Obvious opportunities from sponsors with strong track records executing very similar transactions, or
Deals with demonstrated traction and clear recent data points showing demand.
Both deals (2) and (4) in our list above would not have gotten done without the sponsor having clearly demonstrated demand and pricing for their products. This is particularly true of an unpopular category such as office; the sponsor had to pre-lease almost half of an unbuilt office tower before securing financing. For many sponsors, this will be an unattainably high bar.
Of course, developers with strong track records and relationships can still make deals happen, albeit fewer and at worse terms than in prior years. The northeastern condo deal (3 above) is an example of a veteran sponsor making a transaction happen.
Time
But even those experienced developers with strong relationships agree: getting a deal done today takes time. That’s why the condo developer in (3) inked a twelve month contract period on their development site.
While not every seller will agree to a long contract period, many are recognizing that they have little choice in today’s market. If no good purchase offers are incoming, sellers’ opportunity cost of having a site sit under contract with an experienced sponsor is lower. Sellers may also be willing to bargain other terms; for example, some sellers’ financing or JV arrangement could make a deal more likely.
For sponsors, negotiating a longer contract period may be worth the additional cost. Having more time not only makes a deal more likely to happen but ensures that the developer isn’t in a poor negotiating position–up against a hard deadline when trading contract terms with LPs and lenders alike.
The existing lender plays along
When handling distressed assets, in-place lenders can be a major barrier to getting a deal done. Lenders holding notes on assets struggling to pay debt service face two bad options:
Foreclose on the developer, taking control of the asset;
Sell the note at a discount.
Neither path is particularly appealing. A foreclosure process can take years, as the developer or borrower can file for bankruptcy protection. During that time the lender’s capital is locked up, earning no return. And when the lender does finally win control, he or she must now attempt to sell or operate a distressed asset that has likely been neglected for some time–hardly an exciting proposition.
Selling the note at a discount is hardly more straightforward. The lender must find a buyer willing to take on a headache that the lender doesn’t want. So interested buyers will likely demand a steep discount, forcing the lender to take a significant write-down to move the asset off their books. On this plus side, this allows the lender to move forward and redeploy capital, avoiding years of litigation.
But today, many lenders are choosing a third option: do neither. By kicking the can down the road and refusing to foreclose on the property or sell the note, lenders are preserving the illusion of stability and calm. Unfortunately, this means that markets can’t move forward and properties are stuck in a state of limbo: not doing well enough to generate a return that would make anyone happy, but not doing so poorly that the lender is forced to take action.
The distressed deals getting done right now have in-place lenders that are willing to work with their counterparties to “unstick” these assets, even if it means taking their lumps today.
Strong Fundamentals
Finally, the deals getting done today are in sectors or sub-sectors with strong underlying fundamentals. Generally, this means one of two things:
A deal in a “hot” category that is benefiting from strong capital flows. Some single- and multifamily housing are still included here, as are trendy categories with strong secular tailwinds such as data centers and renewable energy.
A deal in a “colder” category that benefits from project-specific tailwinds or clear and obvious demonstrated success (see point 3 above).
While project-specific tailwinds in an off-trend sector can take many forms, they often relate to submarket-specific factors. For example, the condo project detailed in story #3 above is in a very supply-constrained submarket with strong data from the secondary market on condo sale prices and trends. So while a Type I luxury condo project would struggle to raise financing in many markets, local factors can trump the macro narrative.
And some sectors seem almost immune to rising rates and skittish lenders. Fueled by trends in AI, data centers are still getting built in record numbers. Net lease retail with quality tenants can get done, as can projects with specific subsidies such as historic tax credit and LIHTC projects.
Today’s real estate environment is the juxtaposition of two separate truths. On one hand, nobody ever went broke by sitting on the sidelines for a period of time, and cautionary tales abound of investors buying at the peak of the market in 2021. But capital is still available for the right deals, and markets like today’s can unearth opportunities that simply aren’t available in frothier times. While it may seem that the real estate landscape has frozen over, warm pockets are still out there.
—Brad Hargreaves and Eric Brody
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