The Return of Mezzanine Financing

Mezzanine financing, filling the gap between first mortgage lending and the equity that investors have to finance, has returned with a vengeance. As Joshua Stein reported in the April 2013 issue of this magazine, “Today, first mortgage lenders want to lend again, but it’s very much not like 2007 all over again. Proceeds are down, conservatism is up, and many borrowers find themselves with a gap between the equity they’re willing to risk in a deal and the first mortgage financing they’re able to find.”

With traditional lenders and Wall Street CMBS offering leverage of 60 to 75 percent, mezzanine lenders allow borrowers to finance between 80 to 90 percent of the capital stack—at rates significantly lower, in certain cases, than in the boom days of 2007. In discussions with a number of mezzanine lenders, pricing can range from as low 6 percent to as much as 14 percent depending on the asset and other circumstances.

“I have seen pricing as low as Libor plus 550 from a bank on a multifamily portfolio in New York City,” said Shawn Rosenthal, an executive vice president at CBRE’s debt and equity finance group. “And from 6.5 percent on a major Manhattan office tower to a high [in the] 12 to 15 percent range. It all depends on risk profile. Major factors in the overall pricing include leverage, last dollar debt yield, geographic market and who the sponsorship is on the deal.”

Mezzanine financing comes in a variety of forms from private mezzanine loan firms, finance companies, mortgage REITs, private equity firms, hedge funds, institutional investors and investment banks.

“We have seen more and more deals being done with mezz rather than equity,” said Matthew Galligan, president of CIT Real Estate Finance. “It seems to me that the rates are unrealistically high still, although the structures have gotten more aggressive. The good news is that mezz is prevalent in deals with market risk, thereby functioning as a buffer to the senior lender’s credit risk.”

Mr. Rosenthal said that “many players are involved,” noting that these include large insurance companies, pension funds, large institutions and pension fund advisers, funds both large and small (Apollo, Starwood, Blackstone, Redwood, West River), REITs (SL Green, Vornado) and large private owners (Harbor Group).

“Pricing changes by the amount of leverage. As you scale up in leverage, pricing scales up as well,” he added. “I would say 90 percent financing is still rare, and if it happens, the pricing for the top 5 to 10 percent is equity in nature.”

Ronnie Levine, a managing director at Meridian Capital Group, concurred with Mr. Rosenthal.

“There is a significant amount of money that has been raised in the mezz space, and the market has become very competitive as a result,” Mr. Levine said. “We have seen rates compress from the double digits down into the 7 to 10 percent range.”

Recently, many of New York City’s most notable financing transactions have been provided by real estate investments trusts. In March 2013, SL Green Realty announced the $925 million bridge financing (representing 84 percent of the capital stack) for the Sony Building at 550 Madison Avenue—purchased for $1.1 billion. The loan consists of a $600 million senior loan originated by Bank of China, a $175 million senior mezzanine debt, which SL Green sold to a private investment manager, and a $150 million junior mezzanine debt originated by SL Green. Following the completion of the financing, SL Green sold half of its interest in the junior mezzanine debt.

In May 2013, Apollo Commercial Real Estate Finance, a NYSE REIT, announced the closing of two mezzanine loan transactions totaling $76 million. The company provided a $32 million mezzanine loan secured by a pledge of the equity interest in a borrower that owns a portfolio of 15 warehouses. The mezzanine loan is part of a $322 million, 10-year, fixed-rate loan comprising a $220 million mortgage, a $70 million senior mezzanine loan and Apollo’s $32 million junior mezzanine piece. The REIT’s loan basis represents a loan-to-value ratio of 75 percent.

The company also provided a $44 million mezzanine loan secured by a pledge of the equity interests in a borrower that acquired five adjacent commercial buildings in the Gramercy Park neighborhood that are expected to be converted into multifamily rental apartments. The mezzanine loan is part of a $128 million floating-rate loan comprising an $84 million first mortgage and the REIT’s $44 million mezzanine loan. The loan basis represents a 78 percent underwritten loan-to-value.

Mezzanine financing is not limited to office buildings, hospitality, retail and industrial, either. In June 2013, Cushman & Wakefield’s equity, debt and structured finance team arranged the sale and recapitalization of Cirkers Fine Art Store & Logistics, located at 444 West 55th Street. The transaction involved securing $39 million of debt financing, as well as private equity on behalf of the new ownership. The 10-year senior and mezzanine financing was provided by Redwood Trust.

“We’re seeing an active mezz market on all fronts—permanent loans, acquisition and development,” said Simon Ziff, president of the Ackman-Ziff Real Estate Group. “We recently arranged a $200 million acquisition where we arranged the debt, mezzanine and equity, and the mezzanine was arguably the most competitive part of the stack.”

Competition is expected to heat up as the appetite for mezzanine debt increases. With rising prices for real estate assets, institutional buyers are finding it harder to make their equity returns, preferring to invest on a risk-adjusted basis. These returns are generally on a current basis, as opposed to requiring one to wait three to five years for liquidity or a sale of the asset to generate an IRRA.

As some developers look to increase their leverage and lenders remain conservative in the levels of first mortgage financing, industry leaders expect more and more lenders to join the list of sources for mezzanine financing. However, they will no doubt have to compete with large overseas investors who are also seeking mezzanine pieces—including the Canadians, the Israelis and investors from other Middle Eastern countries.

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