Rising mezzanine and preferred equity prices, combined with ever-higher land and real estate prices in New York are causing more borrowers and sellers to rethink deals, according to Kramer Levin Partner Jay Neveloff. In some cases that simply means reevaluating their approach to financing acquisitions and developments, while for other buyers and sellers it means “second thoughts” about closing a deal, he said.
“Over the past two to three months a growing number of people have started to reconsider transactions due to pricing issues,” Mr. Neveloff told Mortgage Observer. “The pricing for mezzanine debt has continued to increase steadily. That’s a result of supply and demand and it’s also result of borrowers seeking greater leverage in transactions.”
The Lawyers’ Issue
In the past year, the purchase price for New York real estate has increased dramatically in almost every sector, especially land and construction costs and acquisition costs for existing retail, apartment and hotel properties. Land prices in Manhattan alone have increased more than 40 percent in the past year, according to data from the commercial real estate brokerage firm Avison Young.
As a result, the dilemma for borrowers is finding the cheapest and most efficient way to complete the capital stack. With banks and other traditional lenders typically willing to finance between 60 and 70 percent of a total development or acquisition, if not less, sponsors are left with somewhat limited options on how to finance the rest—equity, preferred equity, mezzanine debt or EB-5 funding, in most cases.
For those without high liquidity or access to EB-5, mezzanine debt and preferred equity become necessities, Mr. Neveloff said. As of the second half of 2014, pay rates on mezzanine deals in New York run between 10 and 12 percent, while accrual rates run between 12 and 15 percent, he said. For preferred equity deals, pricing gets more complicated and more expensive.
Some are reticent to tap preferred equity because questions linger about how a preferred equity lender is treated in the event of foreclosure, said Bruce Stachenfeld, a partner at New York law firm Duval & Stachenfeld. He has found a locus of dispute is whether the sponsor gets paid after a preferred equity lender is wiped out in a foreclosure. “Does the borrower just remain in a vegetative state but still get its upside?” he and his clients wonder, he said.
Others say mezzanine prices are not dissuading borrowers. Ronnie Levine, a managing director at the Manhattan-based mortgage brokerage firm Meridian Capital Group, said rising land and real estate costs in New York outweigh the cost of mezzanine debt.
“I don’t think it’s the mezz costs,” he said. “Really what’s happening is that senior mortgage lenders are underwriting to a certain basis per net sellable foot. If land prices keep going up and the senior mortgage lenders are not increasing their appetite for risk, then the developer has to borrow more mezzanine capital or put in more equity.
“You could make the same argument that developers are undercapitalized,” Mr. Levine added.
There are still plenty of deals getting done, according to Mr. Neveloff, but there are new complexities, he noted. “It’s not a gold rush anymore,” the real estate attorney told MO. “It’s people looking hard at deals, looking hard at projections and analyses and making more careful decisions.”