When traditional commercial real estate loans and borrower equity aren’t enough to close a deal, mezzanine loans can provide the 10 percent to 20 percent injection that senior lenders and investors may be looking for, if they’re either unwilling or unable to provide it.
It’s difficult to pin down how often mezzanine loans — as well as preferred equity, a similar product in the middle of the capital stack — are being utilized by today’s commercial real estate investors. On a global scale, however, as of this past September, there were nearly 100 debt funds with some $37 billion in capital to invest in high-yield products like mezzanine financing, according to a report from real estate data provider Preqin.
Michael Riccio, senior managing director for CBRE Capital Markets, spoke with Scotsman Guide about lender and investor appetites for mezzanine and preferred equity financing in today’s commercial real estate world.
What is the current market like for mezzanine and preferred equity financing?
It has been a very long, good, positive cycle for commercial real estate, really starting very slowly in 2010 and 2011, and every year, a little bit better. That’s reflected in our numbers at CBRE — every year has been better than the last, including 2017.
When you get that long in the cycle, many times investors look at the risk of equity versus their risk of debt. And mezzanine kind of plays in the middle, kind of between those two risk spectrums. Sometimes, people look at mezzanine as a little safer than equity, but you get a little more yield than debt.
All these debt funds have been created — more than ever before — so it’s a very popular place and there are seemingly new lenders every day. The current market is robust, it’s very competitive, pricing and spreads are compressing, and we’re seeing more and more aggressive players trying to win business in this space.
Are there specific property types or U.S. markets where this financing is in higher demand?
In major markets, you have players that will do bigger deal slices. … If you’re doing bridge [lending] in New York City, Los Angeles, San Francisco, Chicago, etc., you’re going to have players who can do big mezzanine slices — $50 million-plus, $100 million-plus.
There’s a lot of stuff going on in the secondary markets and even in the tertiary markets. Relative to property types, I think, the four major food groups [office, retail, industrial and multifamily] are certainly in play for both preferred equity and for mezzanine financing. … Hotels are much more selective. Not everybody does hotels. It’s sort of financing a business as opposed to straight real estate.
The interesting thing is that, in my 36 years or so in this business, I have never seen deeper, more experienced capital that is available to investors today. … There are bridge lenders who focus on the $3 million to $20 million deals, or the $1 million to $10 million deals.
What are the major risks of these transactions that commercial mortgage brokers should be aware of?
One is, the higher you go in the capital stack, the more risk there is, and that’s why you get paid more for doing mezzanine [lending]. That’s the major risk. The other risk is that there’s something called an intercreditor agreement. That’s the agreement between the two lenders as to how things will work if maybe things don’t go so well.
The only other risk is, when you’re trying to close a deal and now you’ve got two lenders … everything has to come together at the same time. Two sets of attorneys, two sets of originators. It makes it just a little bit more cumbersome.
Will rising interest rates have an effect on mezzanine lenders, or are they more insulated than senior lenders?
Treasury rates and Libor rates have risen for senior loans. … You put a piece of mezz on top of there and it makes everything higher. It does create a little bit more risk. The higher those rates go, the more stress there is on the income from the property to produce enough to cover all the debt service.
The credit spreads for mezzanine or preferred equity have really come [down]. They’re riding on the same train track as the senior loan and if that train goes off the track, it goes off for both lenders, so I don’t really think that they’re more insulated.