Several years ago, few would have
expected to see gap financing providers, a
wide category that includes preferred
equity, mezz financing and bridge loans,
to reach very far to secure double-digit
returns. Demand, it was predicted, would
surge toward this capital as the expected
tidal wave of overleveraged properties with
debt coming due swamped the market.
That didn’t happen, of course, or at least
not to the extent that was predicted. Asset
values rose enough to mitigate the gap
exposure that existed with basic properties.
Indeed, just last month the Green Street
Commercial Property Price Index increased
by 3%, officially marking property values’
recovery to pre-recession levels.
Demand does exist for gap financing, of
course—the recovery of the commercial
real estate markets all but ensured that.
That demand, however, is just not desperate, at least not in most cases. Hence capital providers must step up and be competitive to get the deals they want.
Nowadays, such financing structures as
the one arranged for the Breakers Resort
in Denver, are fairly commonplace. This
spring, HFF secured $230 million in
financing for the six-village, 1,523-unit
community on behalf of the Bascom
Group LLC. The funding consisted of a
$165-million first mortgage, a $26.3-mil-
lion mezzanine loan, and $38.8 million of
preferred equity. The mezzanine loan and
preferred equity were provided by
Prudential Real Estate Investors’ $805-mil-
lion US Real Estate Debt Fund. Proceeds
were used to refi the existing mortgage
and mezzanine loans, buy-out the existing
institutional equity partner and invest in
future renovations.
This is not to say the crash and subsequent Great Recession have receded from
memory. Their effects are still quite apparent in lending markets, with lower leverage ratios, as they say, now the new normal.
Property owners are not seeking to lever
up deals or balance sheets with mezz
financing as they did in 2005—nor could
they, at least in most cases.
Also, mezz lenders have learned to be
leery of borrower and builder exuberance for projects, especially in asset classes
that might be verging on oversupplied.
“Construction mezz lending has a lot
more risk on it and sometimes even the
best developer can get into trouble,”
Garth says.
mezz and gap-finance providers are dealing with their own competitive issues.
There is a lot of new entrants in this
finance market, certainly more now than a
year ago.
Also, senior lenders are becoming more
aggressive and lending higher in the capital stack. “Three years ago they were at
“The mezz
piece is
getting
smaller
and going
into more
secondary and stronger
tertiary markets.”
60% loan-to-cost,” Garth says. “Now it is
65% to 75%. Also, I’m seeing the mezz
piece getting smaller and going into more
secondary and stronger tertiary markets.”
Another moving piece is the uncertainty around interest rates. Recently
Federal Reserve Bank chairman Ben
Bernanke indicated that there was an end
in sight to the central bank’s quantitative
easing program. There was no specific
deadline, naturally. The commercial real
estate community, of course, knew this day
was coming.
The question in the minds of real estate
lenders and borrowers, of course, is how
quickly this change will happen. That
issue was among the top concerns cited by
respondents in the Real Estate
Roundtable’s recent sentiment survey.
No one anticipates that rates will rise
any time soon, Jeff DeBoer, chairman of
the Roundtable, says, “but typically an
investor has an exit horizon. Where inter-
est rates will be when an asset is sold or
refinanced is a big question.”
“People are definitely becoming wor-
ried about interest rates rising and cap
rates expanding,” says Ronald Dickerman,
president of real estate private equity firm
Madison International Realty, in New York
City. “It’s hard to expect that cap rates will
remain in the fives or low sixes and that
you’ll be able to exit a transaction at the
same cap rate at which you entered.”
Gap finance providers are, in short,
feeling pressure to be both competitive
and cautious. On balance they appear to
be erring on the side (in some cases, far on
the side) of competitiveness.
