The U.S. commercial real estate market, excluding parking lots, is estimated to be $11.5 trillion in size, according to a 2010 report by CoStar Group Inc. (NASDAQ: CSGP) CEO Andrew Florance. In terms of physical space, the same report estimates that the U.S. has over 56 square feet of retail space per person, which when multiplied by the 313 million people living in the US, points to an enormous market that affects the daily lives of just about everyone.
After the credit crisis in 2008, the commercial real estate market lost an estimated $4 trillion in value as credit dried up. The high profile bankruptcies of companies like General Growth Properties Inc. (NYSE: GGP), a U.S. shopping mall REIT, contributed to this decline by shaking investor confidence and adding properties for sale. Since then, the market has begun to recover, helping reignite investor confidence in commercial real estate.
The problem is that financing for some commercial real estate projects remains difficult since many banks are still reluctant to completely get their feet wet due to remaining legacy loans still burdening their balance sheet and are now laden with new regulations that inhibit their ability to jump on certain opportunities. In this article, we'll take a look at how these problems have created an opportunity for Omega Commercial Finance Corporation (OTCQB: OCFN), a provider of niche commercial real estate lending products and various other financial services to this space.
Role of Traditional Lenders
In the past, large banks were the traditional lenders for financing commercial real estate. For example, Bank of America Corp. (NYSE: BAC) will lend up to 80% of a property's value to purchase land or an existing commercial real estate project. The owner's assets would secure the loan; potentially including his or her owner occupied real estate. Over time, the borrower would repay this loan using proceeds from the property's rent-roll obtained from the tenants leased units.
The problem with this model is that many large banks have tightened their lending standards amid increasing government oversight. For example, newly proposed regulations like the Premium Capture Cash Reserve Account ("PCCRA") could require certain lenders to keep "skin in the game" with a minimum 5% stake. This requirement has reinforced the banking sector's preference for only the safest assets, as some in the industry are still stuck with toxic assets on their balance sheet.
While traditional lenders will continue to originate most large commercial real estate loans, smaller, niche non-regulated institutions have begun to play a larger role. These companies have greater flexibility when structuring commercial real estate financing, as well as fewer regulatory hurdles limiting their growth than traditional lenders. The result could be significantly higher returns for investors over the long-term as the market continues to recover with quality loans and sound borrowers remaining on the streets.
Niche Lending Opportunities Exist
Omega Commercial Finance Corporation aims to generate attractive yields and consistent interest income from short and medium term commercial real estate loans, according to its latest 10-K filing with the SEC. Management plans to accomplish this through a combination of senior debt loans, mezzanine or subordinated loans, preferred equity and other equity participation financing structures, as well as factoring and other special forms of financing.
The company follows a "conservative lending" profile for these loans; they prefer first lien senior debt mortgage loans and high debt service structured financing programs rather than riskier loans with low debt service and high loan to values, mezzanine financing, or equity positions. Management has assembled a team of highly qualified individuals to ensure that all of the financings that it originates generates returns that are higher than the commensurate level of risk associated with the financing.
Once originated, the company has enabled itself the luxury through its business model and company structure the option to securitize the loans in order to generate recurring revenues, recapitalize its balance sheet, and maximize shareholder value. These securitizations, known as commercial mortgage backed securities ("CMBS"), involve grouping multiple loans together in tranches to mitigate the risk of any single loan on the overall portfolio and sell into the secondary market. Management feels that these CMBS offer a compelling value, particularly in Centralized Business Districts ("CBDs").
The overall outlook and trend in the CMBS space for 2014 looks very promising. There appears to be a rising level of comfort among lenders. According to a recent story covered in Bloomberg, the commercial mortgage-backed securities market has high expectations and ranks at the top for expected change in availability. Several respondents estimated originations might exceed $100 billion in 2014.
Potential Investment Opportunity
Omega Commercial Finance Corporation has made a lot of progress over the past few years building its business to unlock this value with great timing poised and well positioned to attack the vast opportunities the upswing in the market are creating. Management made a number of acquisitions, including a minority stake in VFG Securities & Advisors, a full-service broker-dealer and advisory firm with $170 million in assets under management. The team also established Omega Capital Street to become its direct balance sheet lender and Omega Factoring to provide additional accounts-receivable financing services.
Three private investors also purchased a total of $3 million in equity from Omega Commercial Finance Corporation at a $0.10 per share valuation via a Direct Public Offering. These transactions will assist management finance its future acquisitions and pave the way towards execution of its business model. Over the long-term, the team hopes to up list to the American Stock Exchange ("AMEX") and become a leading lender with the built-in synergies necessary to harvest a broad range of financial products and services.
With a market capitalization of just $8.9 million, investors have a unique opportunity to capitalize on Omega's potential growth rates and the commercial real estate sector's recovery. More importantly, as further illustration to this point, they recently announced a strengthened balance within their filed Q3 financial statement that garners a book value of $0.17 per share due to a record investment amount of $43-million dollars in capital.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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