Heller's nimble niches

Through nimble investing and by offering financing for many property types, Chicago-based Heller Finance Inc. has become a leader in middle-market commercial real estate finance and a leading provider of capital to the vacation ownership industry. Last year, Heller Real Estate Finance (HREF) not only created $1.6 billion in new business and had lending assets and investments of $2.9 billion, but also was responsible for almost 16% of Heller's total lending and investments. The company is positioned as a full-product provider with the ability to respond quickly to real estate finance opportunities.

Currently, HREF offers a wide array of products: a structured finance program that includes floating-rate debt and high-yield floating-rate debt products and mezzanine loans; loan syndications; fixed-rate loans for securitization; CMBS securities purchases; affordable housing, vacation ownership and hotel lending; and lending in Canada and Mexico. This variety of offerings showcases what John Petrovski, group president of HREF, describes as his group's approach toward investment and loan opportunities: nimbly shifting capital and resources to underserved market niches.

These products are structured toward a range of property types including office, retail, industrial and multifamily properties, and manufactured housing communities and self-storage facilities. "We call it structured because each deal tends to be a little different," explains Petrovski. "Listening to the client, hearing what the financing needs are, you basically have to structure a tailor-made solution to their acquisition or redevelopment."

In 1999, senior secured loan transactions averaged about $10 million, while the average mezzanine secured loan transaction was about $4 million. The average vacation property transaction was about $15 million.

"I'd say the one thing that's characterized Heller over the years has probably been its ability to evolve depending on what the market needs for a particular financing," adds Petrovski. "We tend to go after the underserved niche and offer that product."

If the competition for a product becomes too aggressive and the risk/reward ratio goes out of balance, the company backs off. According to Petrovski, his team is committed to profitability over the long haul; short-term, aggressive volume in search of profits or creating tomorrow's problems is not Heller's focus.

Untapped niches Looking for untapped niches has been Heller's strategy from the beginning. Walter Heller, a Chicago native and heir to his father's animal byproducts business, founded the company that bore his name, Walter E. Heller & Co. From the 1920s until the 1970s, Heller found profits - and losses - through various enterprises such as financing auto loans, films like "High Noon," and television shows like "Lassie." In the 1980s, Japan's Fuji Bank bought the company, renaming it Heller Financial Inc. In May 1998, Heller went public, and Fuji continues to be a majority shareholder, owning 57% of the company.

Heller Financial Inc. now consists of six highly focused business groups: corporate finance, real estate finance, leasing services, healthcare finance, small business finance and international. In April, the company reported a net income of $75 million for the first quarter, up 32% from the same quarter in 1999.

In the next five years HREF predicts it will continue to grow by seeking out new niches for real estate investment and by expanding its already successful line of financing products.

Opportunities abound The bond-market turmoil in 1998 is one of the factors that led to HREF's focus on multiple-product lending. Realizing its focus on fixed-rate lending was too narrow, Heller decided that having multiple products contribute to the bottom line was a better strategy than relying on one major product and several smaller products. Three products that are doing well today are hotels, timeshares and affordable housing.

According to Petrovski, while potential problems with oversupply and fear of an inevitable economic slowdown have caused many financing companies to shy away from hotel lending in the past few years, it's an area Heller targets for greater volume.

Michael Rowan, managing director of Specialty Businesses, explains Heller's position: "What we've done for our group is focus on what we think are the strongest brands for the mid- to upper-scale hotels, full service and some extended stays," says Rowan. "We believe there are still niches in the market that offer some good investments."

Looking at the hotel industry through "a really narrow focus," Rowan explains, "We're not just out there doing hotels. We're not going to do the limited-service hotels you see going up in every corner. We try to find the sites where demand will support another hotel, and the reservation systems and the brands will make that hotel a success."

His group focused on Beverly Hills, Calif.-based Hilton Hotels Corp. and Washington, D.C.-based Marriott International. "I think we're most excited about a program with Hilton Hotels designed to really grow two or three of their brands: Embassy Suites, Hilton Garden Inns and the Homewood Suites by Hilton," says Rowan. "We'll give take-out financing to a borrower so he can obtain construction financing and Hilton will work with us on that."

Heller used its ability to invest nimbly by getting in and out of the hotel-lending arena as changes in the business climate and competition occurred. "Heller did hotel lending in the late-1980s, exited hotel lending in the early-1990s, and re-entered hotel lending in 1994," explains Petrovski. "By 1997, we really curtailed our hotel lending, and in 1999, we revved up our hotel initiative again. I think that is as good an example as any - when we see an underserved market we get involved. Then, when there are a lot more people chasing deals than there are deals to be done, it's time to shift your capital and resources to something else."

HREF is one of the leading providers of capital to the vacation ownership industry, specifically in timeshare project finance. According to Rowan, this arena offers a lot of opportunities because in the past five years, "It has grown at a rate of approximately 15% per year. [The timeshare industry] is really driven by the baby boomers and people 45 to 55 years old."

Because the demand for low-cost housing exceeds supply, this year Heller has expanded its affordable housing program to include an affordable housing guarantee product. Heller's affordable housing initiative allows investors to purchase the tax credits for the development, while Heller assumes the performance risk for a fee.

"Our group's goal is to come up with new products that we can keep in the specialty groups that fill certain niches that come up as time allows or the market dictates," says Rowan. "[While we] do most things domestically, we've done some loans in Mexico, and we'll continue to do that."

Areas to explore Doing debt-related investing may be prudent in today's real estate environment. "In the plateauing value environment of the current commercial real estate market, it is probably a good time to do debt because your loan-to-value ratios will hold or decline as your loan amortizes," says Petrovski. "Frankly, it's tougher to pencil out a strong return to an equity investment opportunity than to find good debt opportunities."

At the same time, Petrovski points out that the CMBS market has slowed quite a bit, which is one of the reasons Heller continues to focus on being a multi-product lender.

"If you look at the volume of how many of those loans were originated, and how many CMBS bonds were sold over the last five years, it's been a really big roller coaster ride in this industry," he says. "In 1998, there was probably close to $90 billion of CMBS bonds issued, which is a huge volume. Last year dropped off, and 2000 is dropping off even faster."

Heller's focus is on product diversification and agility in investing. Staying open to new opportunities and ideas that come from transactions, clients or underserved market niches is what Petrovski believes will help create new business for the company. "I would say that Heller Real Estate will be bigger over the next five years," predicts Petrovski. "We will continue to grow as Heller Financial continues to grow. We would like to have [our nine-product] pie chart of annual production become a bigger pie and have more sections in it as well."

Besides continuing to investigate opportunities in Canada, Mexico and other international markets, the company "is going to stay close to our clients in the United States," says Petrovski. "As they buy and acquire and invest in properties, we want to be with them because we think there's some money to be made over the next five years."

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