Finding deals that work proves challenging
“The hardest thing for us has been the underwriting at current interest rates,” MacDonald-Korth said. “Most buildings’ financials were not designed to withstand the 520-, 550-basis-point jump in rates from one year to the next. While we have seen our pipeline balloon, especially with banks holding back and credit generally tightening it has just been difficult to get deals to pencil out.”
She provided a hypothetical example: “Where we like a property, we have the sponsor who is going to bring in some cash,” she explained. “We do a debt service coverage-based underwrite, and it’s hard to get deals to cover at the rates that we need to charge for the market and the level of debt that they currently have on the building that they need for the payoff. So that’s been hard, but we are finding deals that work.”
She described the company’s more nuanced approach to office building investments increasingly includes “Sponsors whose banks accounts are more flush and can bring capital to closing,” she said a an example of what KDM looks for in mulling an office deal. “That helps when you’re lowering the leverage. With respect to office, office underwriting has kind of been turned on its head. It used to be when you were looking at an office building, you wanted a bunch of household names, Fortune 500 companies with big footprints as tenants and that has kind of completely reversed.”
She described the new reality: “Now you’re worried about those tenants downsizing at the end of the lease rather than renewing or possibly leaving the building altogether,” MacDonald-Korth said. Now, it’s preferable to look at a building where downsizing already has taken place and/or containing a mix of reliable tenants albeit not of the fancy Fortune 500 variety: “We’re really looking for rentals where the tenants have already downsized or there are new leases that have come on post ’21.”
She also looks for a “granular” mix of tenants: “Accountants, attorneys, dentists, where they need a physical location to meet with clients. They’re pretty sticky tenants,” she noted. “It’s really kind of flipped in terms of what you look for in an office these days.”
Source: mpamag.com