FEATURE: Who's lending now?

When private equity real estate firms previously considered debt origination they were primarily focused on mezzanine financing. However, increasingly attractive returns for senior positions are enticing some to climb further up the capital stack. PERE Magazine, April 2009 issue

Debt is an extremely rare commodity in today's real estate world, but for some private equity real estate GPs such scarcity is proving an ideal investment opportunity – with the origination of senior loans.

Once previously the preserve of conservative investors, such as banks and life insurance companies, whole loans and senior debt positions are beginning to shed their image as just low-risk, low-yield, long-term investments. Now, as traditional lenders retreat en masse from debt origination, non-traditional lenders are starting to fill the gap.

There is debt available. It's not coming from your traditional lending sources, that's all.

“There is debt available,” Rick Rosenberg, principal in charge of DPFG's private capital markets group, said. “It's not coming from your traditional lending sources, that's all.”

Banks, which have traditionally made up half the real estate lending landscape, have been hit the hardest by the credit market meltdown and the subsequent collapse of the CMBS market. Slammed by subprime losses, most have drastically scaled back their activities in real estate lending, with the UK's Royal Bank of Scotland, Hypo Real Estate, Eurohypo and Credit Suisse among many to have “paused” new originations.

As a result, a majority of banks worldwide are concentrating on existing relationships with “strategic” clients, with all paying close attention to existing loans set to mature this year. A recent report by UK property services firm Savills found that of 100 global lenders it interviewed, only 40 had an appetite to lend for British property deals – on varying terms – and only 12 would consider transactions above £25 million (€27.1 million; $34.6 million).

“There is a real shortage of capital in the senior debt space, let alone other parts of the capital stack,” Jones Lang LaSalle's real estate investment banking managing director, Wesley Boatwright, explained. “There is debt out there – but there just isn't enough of it to go around for what's needed.”

Breaking the mould

There is a real shortage of capital in the senior debt space, let alone other parts of the capital stack. There is debt out there – but there just isn't enough of it to go around for what's needed.

This dearth of debt, however, is proving attractive for many non-traditional players. Among those making their foray (and in some cases, return) into real estate lending are life insurance companies, local and regional banks (particularly in the US) and international banks which have been less exposed to subprime losses (such as Japan’s Sumitomo Mitsui Banking Corporation, Spain’s Santander and Germany’s Deka Immobilien Investment).

Private equity real estate funds, including opportunistic firms, are no exception, with increasing numbers starting to invest in the space through existing funds or seeding the creation of new financial companies.

In the US, core-plus fund managers, such as AEW Capital Management and Buchanan Street Partners, are a “rapidly growing” segment of the origination scene, according to Douglas Hercher, managing director of Cushman & Wakefield Sonnenblick-Goldman. However, he added, there are also some opportunistic players able to achieve even more attractive returns – depending on the financial situation of the borrower.
According to a 12 March capital market report from Cushman & Wakefield Sonnenblick-Goldman, two opportunity funds provided floating and fixed rate interest-only whole loans for 1,200 basis point (bp) plus Libor (the 30-day London Interbank Offered Rate, which at time of press was around 0.5 percent) or interest rates of 12 percent plus a 2 percent fee.

Unlike their more conservative peers issuing debt, the opportunity funds were providing loan-to-values of up to 80 percent (compared to LTVs of between 50 percent and 65 percent), for much shorter periods of time (in the case of the 12 percent plus 2 percent fee, the loan was for one year) and were interest only (most lenders are now demanding some form of recourse and amortisation).
Even originating so-called “conservative” loans though will today secure lender rates which are at least 260 percent higher
than two years ago.

According to the non-profit group Real Estate Capital Institute, permanent fixed-rate financing in the US can be secured today from anywhere between 330bp and 800bp over Treasuries (at time of press around five-year notes were 1.9 percent and 10-year notes 2.9 percent). That compares to spreads of between 170bp to 300bp in February 1999, and between 90bp to 160bp in February 2007.

Grabbing the whole opportunity

New York-based private equity firm Madison Realty Capital is just one of the firms actively participating in the debt space. Co-founded in 2005 by managing partner Josh Zegen, Madison specialises in providing short-term first mortgage financing and buying performing and non-performing commercial mortgages. Over the past three months, the firm has seen a dramatic rise in the scale of whole loan opportunities, particularly from investors looking for partners to help them buy back their own debt.

“We recently had someone with a $20 million, 10-year interest-only loan backed by an office building in South Florida,” Zegen said. “The bank was unable to securitise it and, knowing it was overleveraged, gave the borrower the chance to buy back the debt for $10 million. We were able to secure a senior position by providing $8 million in financing.”

The quality of first mortgage bridge loan opportunities has only become stronger over the last year as the options for borrowing have become more constrained by the day. And in this environment we are only seeing those opportunities get better and better.

Madison charges borrowers between 11 and 15 percent for such deals, but there are many situations where they are able to achieve IRRs of as much as 20 percent, according to Zegen. “If you personally cannot rely on leverage you will do the deal on an unlevered basis – that means you need a higher level of return,” he added.

Madison is not alone though. There are a raft of firms that have used existing funds or seeded new financial companies to take advantage of the opportunities – and returns – at hand. (See Filling the Void chart, below)

Few industry professionals though, have been able to calculate how much uninvested capital is targeting real estate debt investments today. Many participants PERE spoke with wondered whether estimates of tens or even hundreds of billions of dollars sitting on the sidelines ready to deploy were actually accurate.

Compared to the $3.1 trillion to $3.5 trillion of outstanding debt related to commercial real estate, it will no doubt be a drop in the ocean.

But even though few know how much money private equity fund managers have to deploy, one thing they clearly do have is speed.

“Often the reason you are able to get such good discounts on foreclosed properties or discounted debt deals is because you can close quickly,” concluded Zegen. “You go to a traditional lender and it could take you a long time to get the financing,” he added. “The quality of first mortgage bridge loan opportunities has only become stronger over the last year as the options for borrowing have become more constrained by the day. And in this environment we are only seeing those opportunities get better and better.”


Mind the gap

Non-traditional lenders have filled the origination space left by banks and the collapse of the CMBS markets. A recent Cushman & Wakefield Sonnenblick-Goldman capital markets report highlights non-traditional real estate financing that is currently available in the US.

Key: L = Libor; T = Treasuries; LTV: loan-to-value; DPO: direct public offering; S: swaps.

Asset Financing Lender Rate LTV Term Amortisation
Office condo DPO/foating Opportunity fund L+1,200 80% 2+1+1 years Interest only
Retail Fixed Life company 7.5% 50% 10 years 30 year
Retail Fixed Regional bank 7% 50% 4 years 30 year
Multi-family Fixed Agency T+365 80% 5 years 30 year
Hotel Floating Off-shore bank L+350 <40% 3 + 1 years Interest only
Office Fixed Life company 8.5% 60% 7 years 30 year
Condo-MF conversion Fixed Opportunity fund 12% + 2% fee 75% 1 year Interest only
Industrial Floating Opportunity fund L+375 65% 2 yrs + 6 mths Interest only
Multi-family Fixed Agency T+280 55% 10 years 30 year
GSA office Floating/fixed Offshore bank L+300/S+300 60% 5 years 25 year

Filling the void

Below are some of the firms who have entered or are planning to enter the real estate debt origination space, by investing through existing funds or seeding the creation of new financial companies.

Ladder Capital

Formed last year with seed capital from TowerBrook Capital Partners and GI Partners, Ladder – led by former UBS commercial real estate global head Brian Harris – is targeting all sections of the capital stack, from AAA-paper to equity. Harris said there was a “remarkable opportunity” in CMBS and he had closed on $350 million of bonds in the past 90 days, including part of the $7.6 billion multifamily-backed GG-10 deal, issued by RBS Greenwich Capital and Goldman Sachs in 2007. A significant number of the collateral loans for GG-10 are now on servicer watchlists.

Fides Capital Management

Fides launched its first investment vehicle, Fides Real Estate Direct Lending and Distressed Opportunity Fund, in February targeting up to $300 million. The firm said it will lend money to quality developers in distressed situations and target pure equity plays.

ING Clarion

ING Clarion Capital has hired former CIT managing director Timothy Zietara to build its debt platform. Zietara was head of CIT's real estate structured finance and equity group. The New York-based arm of ING Real Estate is currently targeting $1 billion for its ING Clarion Debt Opportunity Fund III.

LRG Capital

After struggling to secure financing for its equity fund, the Larkspur, California-based firm decided to launch LRG Capital Real Estate Debt Fund I targeting $500 million. The firm will originate senior loans in the US, with LTVs of around 60 percent, up to seven-year, fixed rates of around 7.5 percent and up to 30-year amortisations. Loan sizes will be around $10 million.

CBRE Investors

CBRE Investors is reportedly seeking to raise $1 billion for two open-ended funds that would originate and buy commercial mortgages. The high-yield vehicles would each use about 50 percent leverage, with the CBRE Capital Partners fund targeting low teen returns, and the CBRE Capital Partners Special Situations fund targeting returns of up to 20 percent. Loan-to-value ratios would range from 55 percent to 75 percent, according to Commercial Mortgage Alert.

Westbrook Partners

The New York-based firm is believed to be eyeing debt-related opportunities through its $2.5 billion Westbrook Real Estate Fund 8, after appointing former iStar Financial executives David Finkel and Zubin Irani as managing principals for its London office and Kunihiko Okumura, former senior vice president in Lehman Brothers' global real estate commercial mortgage originations and securitisations group, as principal in Tokyo.