Cottonwood Group is hunting for more unique deals requiring creative financing solutions in the multifamily, hospitality and office sectors to fill gaps left by more standard market-based lending options.
The $3 billion Los Angeles-based firm is zeroing in on more hospitality deals linked to leisure travel as well as multifamily opportunities in subcategories such as co-living and student housing to build its portfolio out further heading into the second quarter of 2022.
Jeffrey Horowitz, managing director and head of investments at Cottonwood, told Real Estate Capital USA the firm may not be the cheapest source of capital available for a given project, but it is marketing itself to borrowers as a means of solving timing pressures or sourcing financing beyond standard market packages. Cottonwood originates loans from $25 million upward to $1 billion, typically operating in the $50 million to $300 million range.
Cottonwood’s approach has helped the firm expand its lending remit to include more co-living, student housing, office and leisure travel assets in recent months, including a bet on New York City office space at a time when remote working trends are leaving a question mark on the future of office work in the near term.
The firm is not shying away from opportunities in categories perceived as being out of favor in the current environment, according to Horowitz. The appetite is exemplified in the firm’s late-February closing on a $104 million acquisition and renovation loan for The Scottsdale Resort at McCormick Ranch, a destination hotel located in Scottsdale, Arizona acquired by Florida-based commercial real estate investment and development firm Driftwood Capital.
“I really liked that deal, because it’s really a kind of a perfect candidate for what we look for and combines a number of elements in our absolute return strategy,” Horowitz said, noting that the economics for the Scottsdale play were optimal. Cottonwood secured the deal in December 2021 despite other competitive bids.
Cottonwood views the leisure travel market as broadly rebounding based on 2021 trends. With Scottsdale specifically, there were more options for nearby entertainment than just a circuit of golf courses to sustain traveler interest.
“There is a lot of incoming leisure and special event demand and based on all those drivers and favorable demographics, they really helped us understand the market opportunity there,” Horowitz said.
The Professional Golfers Association’s annual Waste Management Open, the 2023 National Football League Super Bowl and the 2024 National Collegiate Athletic Association Final Four basketball matches are all booked for the greater Phoenix area near Scottsdale atop the standard Major League Baseball spring training that would typically occur for West Coast teams, barring the current lockout.
On other perceived out-of-favor opportunities, Horowitz said the firm entered into a transitional bridge loan for a New York office concept with smaller floor plates where each floor effectively belonged to a single small or medium-sized tenant able to capitalize on the smaller size. He said typically small and medium-sized businesses in the area have to occupy shared spaces to afford the same footprint.
Horowitz said there has been a flight to quality for Class A office space in New York especially because rents have fallen and tenants switching offices can now afford more premium spaces than before.
Cottonwood remains interested in any opportunity that deals with “beds, sheds, meds and desks,” according to Horowitz. The firm has steered away from touching standalone retail for lending opportunities and found slightly more interest in prime retail and experiential retail, though the latter was boding better prior to the pandemic’s onset.
In tandem with Cottonwood’s lending approach, Horowitz said the firm does not have to solely focus on one asset and one geography – such as hospitality – to sustain business momentum. Cottonwood has been building more defense structures into its underwriting process as well, allowing the firm to better avoid impairments on originations carved out before or during the ongoing covid pandemic across its portfolio.
“It’s really important for us – even if it looks like the best deal in the world – to understand what our strategy would be if something were to go wrong rather than worry that we need to close this deal or else we’re going to miss an opportunity,” Horowitz said.
On defense structures, the firm looks for a typical suite of protections when it comes to lending, including a mortgage lien on the land, an assignment of all contracts related to the property, a pledge of equity interests in the borrower entity where possible and recourse from the sponsor where appropriate.
Cottonwood also underwrites an opportunity for multiple use cases, such as evaluating student housing opportunities to see if the deal will still work as a traditional multifamily deal if market opportunity changes. The firm looks to account for details such as floor plate efficiency, in case a property can be repositioned more appropriately.
On highly leveraged deals where Cottonwood anticipates needing to step into the ownership position, the firm also maps out a potential business plan and considers its internal resources to assess how viable the project will be for delivering expected returns to investors prior to closing, should such a takeover scenario unfold.
The firm currently maintains mixed-use, residential, commercial, hospitality and gaming projects in its portfolio spread across San Francisco, Boston, New York, Las Vegas, Seattle and Phoenix, among other metropolitan areas.
In upcoming months, Horowitz said Cottonwood is keeping eyes on an anticipated tapering of the commercial real estate market with the Federal Reserve looking to continue its interest rate increase plans, which could in turn make deals harder to complete. He noted that over the last year-and-a-half, the industry has benefited from cheap borrowing rates and easy availability of capital.
“We feel comfortable taking on those risks because of our own operational and development capabilities,” Horowitz said. “It provides us a unique advantage for our own investors, who can be assured that we will never be in a position with a half-built building we don’t know how to complete ourselves in the most extreme, dire scenario.”