Today we are continuing our conversation around commercial financing, we will learn how you can get a commercial real estate loan, ways to partner up with seasoned operators, how to find lenders that can make creative financing available to you, and a few other valuable things. We are interviewing John Pascal, Managing Director of Paramount Capital Advisors (PCA). Before joining Paramount, John served as Principal of JMB Financial Advisors where he originated over $1 billion of capital. John also served as SVP and CIO of Brookdale Living Community, a company that provides senior housing nationwide. He also has experience with the acquisition of multi-family, industrial, retail and office properties on behalf of institutional clients.

Tell us a little bit about your background
I basically source debt, as well as equity for real estate companies, groups that are either buying, developing, or refinancing their deals. I've been doing this for close to 15 years now, my background prior to that has always been in real estate, both in senior housing or institutional real estate, buying, in addition to senior housing, multi-family, retail, industrial, and hospitality.

I'm so happy to hear that you have been doing this before the last recession, which I'm sure you have a ton of stories to tell us. Why don't we first get started with the very basics of commercial real estate financing: is a job needed for first time investors, do they have to have a current job, does the credit score matter, what is the minimum down payment for that type of investor?
From a lender standpoint it's very important that the borrower has experience executing the business plan that they're proposing. It's a little bit difficult to get financing for first time investors or developers. Generally, who I deal with are more experienced real estate groups because it's just very difficult to finance the deal otherwise. But I would encourage anybody who is looking at getting into the business to maybe partner with, or work with a group that has done it once what they're proposing to do. And it's also important that the borrower has a good balance sheet. Typically a lender would like to see net worth equal to or above the loan amount, and liquidity, meaning cash or marketable securities equal to at least 10% of the loan amount. Those are the prerequisites for a lender to approve moving forward or lending to a borrower.

From a first time investor's perspective, if they are partnering up with someone that has done this before, do you have any idea of how that relationship would work?
It all depends, if the borrower, the investor is guaranteeing the loan, then they're in a position to basically control the deal, earn a promote, meaning that if the deal goes well that they get an additional share of the profits as a result of their willingness to guarantee the loan. And as a result of executing the proposed strategy in a situation where it's a first time investor, my guess is is that they're wanting to have a partner who, because that partner has experience, is going to be more involved both from as a guarantor as well as from the standpoint of executing this proposed strategy. So if that's the case, then that partner is also entitled to something above and beyond what their investment percentage is. I can certainly get into more detail, but I don't want to bore people, because it gets a little bit more involved in terms of describing overall potential structures. It could get complicated, but it really depends on the deals, and on the investors.

We don't mind getting bored on that particular topic. So if you can just give us, let's say on an average range, that would be already very helpful.
If an experienced investor comes in and puts in, let's say, 20% of the equity versus 80% of the equity, then they're going to be entitled to different structures. In other words, if they're putting in only 20% and not guaranteeing the loan, then they're not going to get as big of a promote, another word for it is "sweat equity". If the deal goes well, and they're putting up 80% of the equity and guaranteeing the loan, then they're more of an active investor, and they're entitled to more of that transaction and a bigger share of the profits, or promote. There's no cut and dry formula. It really just depends on the partners, their experience level, what they're doing, and are they guaranteeing the loan? How much involvement do they have in executing the business strategy, unfortunately I can't be more specific because it depends on the transaction.

It is, I hope, well known out there that financing is the biggest deal killer. What are typical deal killers when trying to get a loan?
One thing is what I mentioned earlier, the lack of financial capability, i.e. net worth and liquidity. The parameters for that are more stringent with a traditional bank than they are with a private equity lender. The other hurdle is the experience of the borrower. The more experience, the longer the track record, the easier it'll be to find financing because the lender will have comfort that the borrower can execute on their business plan. Those two things are very important. And then the strategy itself is important. If a borrower says "I can sell this property in a 4% cap rate and that's my way of paying the loan back". It has to be realistic, and proven in the market. Are 4% cap rates prevalent in the market, and can that be proven out to the lender. Those three things are really critical for getting the loan approved.

You were there during the last recession. Can you give us an overview of what your life was like back then in terms of what was happening to the loans? Banks obviously cut back significantly, but at the same time I know that they were begging their good borrowers to take money. Do you mind sharing a little bit of what was going on back then?
Obviously it was a very tumultuous time and a lot of the banks shut down, they either shut down completely or shut down their lending. A lot of the banks were just scared to do anything and it was very difficult to get traditional bank financing. The other thing that happened was the banks were obviously upside down in a lot of loans that they made. They were working out those loans with the existing borrowers and there was opportunity because the banks were anxious to get a lot of this stuff off their balance sheet. So they were willing to sell these properties at discounts or work things out with their borrowers where the borrower could buy out the existing loan at a significant discount. That created opportunities for guys like me who were able to source capital to fund those types of transactions. What ended up happening was that a lot of private equity money was raised and they were able to take advantage of that time to buy at discounts, recapitalize deals, it created a lot of opportunities. There was a lot of money made during that time for those who had the courage, and knew that the world wasn't coming to an end, the real estate world wasn't coming to an end. They took advantage of buying at significant discounts, below replacement costs. There was good and bad, like anything, but it was a tough time.

Are these people that were able to get those incredible deals or renegotiate their loans, are they selling their properties today?
A lot of those deals were already probably sold a few years ago already, profits were realized. The market, especially with rates so low over the last few years, has been very frothy for property sales. A lot of those deals that were done back in the recession were harvested probably in 2013, 14, 15. While some of those may be still around, I think most of that money was made back then.

We're all wondering here what is happening to some investors and, it's good to know that they cashed out. I heard that you are very creative on getting financing, I would love to hear some examples of your creativity.
It all boils down to having a good understanding of the capital markets, a good understanding of which capital sources are doing what, I spend a lot of my time understanding what different lenders with different equity sources are interested in doing. One example was that there was a developer of a hotel in the Atlanta area whose lenders were looking to foreclose on the asset, and the property was in a good location. It just was at the time completed and about a year or so prior to me getting involved, and it was just ramping up, basically it was under water. The vultures were circling, and the borrower came to me to try to figure out a solution. It was a situation where a traditional lender probably wouldn't have looked at this deal because the deal was underwater, but I brought in a private equity firm to recognize that there was going to be some value in the deal. There were probably 15 or 16 lenders on the deal, and we negotiated with each of the lenders to take them out. It was like herding cats. The bottom line was that I found a private equity firm who would do the deal. They certainly charged a lot of money to do it, and today the property is doing great. The developer has realized a bunch of value in the asset. I refinanced that deal two or three times already in the last seven, eight years, we were able to save the asset for the owner and allow him to reap the benefits of the improvement in the market. That was one example of "creativity".

Another example is a situation I'm working on now, which is the development of a hotel in Atlanta. The developer has a senior loan, construction loan proposal, but he's a little bit short on equity. What I've done is there are some creative sources of equity that not everybody knows about, and that one source is called a PACE program and it's a government instituted or program. If you as a developer are spending money on energy saving items like air conditioning or windows, you can basically find equity like money to fund some of that. As a developer, it is basically a cheap source of equity, so that money is priced at 6,5% and amortized over 20 years. It's a creative way of trying to find some more equity for a developer who may be short on capital. In terms of creativity, it really just boils down to knowing what's going on in the market, what are the different capital sources, what are they doing, what are some of the various programs out there that are available to real estate investors. It's just keeping your finger on the pulse of the capital markets.

I hope, you at least get free room in these hotels for life, for doing that.
Yeah, right? I didn't think about that, I should.

What is the best way to find great lenders?
This is somewhat self-serving. What I do is if a borrower needs financing for a deal, I'll either take them to somebody I know. I've been doing this long enough where I have relationships, I do know lenders that I would say are good bankers, I do know other lenders or bankers that are bad, that aren't great to deal with. That part of the answer is just experience, but when looking at a deal  in a market where I'm not familiar with or don't have extensive relationships, you can get a general sense, or I can get a general sense of whether these lenders are good. Are they smirked? Are they driven to get a deal done? A lot of guys will just say no because they don't like being busy, and it's easier for them to say no.

I had one situation a few years ago where the lender gave up on a deal because there was a ground lease on the property. It was a CMDS lender, and they were initially having trouble getting comfortable with financing a deal that had a ground lease. But I knew that the same lender had done another deal with a ground lease. I called the banker and told them that you they've done it before, they should be able to do it now, because he had told me that he can't do it. And I took the time to try to find people within his bank that knew about the deal, or knew about the structure, and proved to the lender that I was working with that it could be done. And it ultimately got done, but it wouldn't have gotten done if I had relied on this banker. You just have a sense of who's going to do the work, and who's going to go to bat for the transaction. This is because some of these lenders, some of these bankers, they're just basically salesman. They don't want to do the work necessary. You just have to get a feel for who's going to work, I have been doing this long enough where I know in certain markets who those guys are, but in other markets, you have to do the research.

Is there anything else that our audience should know?
It's a lot easier to find financing for apartments. A lot of lenders are leery of retail these days for obvious reasons. The same thing goes for hospitality, the view is hospitality basically marks the market every day. In other words, it's the most sensitive asset class to the economy, and people feel in general that we're at the top of the market these days. There's a lot of demand for industrial, so that's a good asset class. Senior housing, same thing, there's a lot of money, a lot of liquidity in that asset class. Self storage, is also positive. Some asset classes are easier to finance than others.

What about office? Do they go hand in hand with retail?
The general feeling is that office has peaked as well because you have leases that could be longer term in nature. There's a baked in cashflow in a lot of cases, so I think you have to pick your spots. In certain markets there's a lot of growth, job growth, etc, I think the lenders are more apt or willing to lend into those markets. And other markets that have stagnated in terms of job growth, or there's some new construction, lenders a little bit more leery. So I think that for the office market in general, you just have to pick your spot. I don't think it's as risky as hospitality or retail as an asset class. It's right in the middle in terms of priority of asset class.

John Pascal
(312) 767-3320