Ms. Mezz: Brookfield’s Andrea Balkan Is On a Mezzanine Debt Mission

Balkan’s team has an ambitious M.O.—winning whole loans on marquee buildings in America’s biggest, most competitive markets, and then selling off the senior debt to partners with more vanilla proclivities. Brookfield is content, thank you very much, to hoard the relatively well-yielding junior debt that remains for the profit of its institutional investors. If the tactic works as designed, it’s a sort of Goldilocks strategy—with just the right risk-reward balance to wow investors while keeping the credit window in check. With five funds under its belt already, the scheme has been a hit. And Brookfield’s 2019 acquisition of Oaktree Capital Management, another investing giant, is sure to redouble its already outsized clout.

Judging by the company’s proven ability to find a crowd of investors for its debt business, Brookfield is doing something right as a lender. Late last month, for a peek behind the curtain at how the company stitches together a massively winning mezzanine portfolio, Commercial Observer spent half a morning with Balkan at Brookfield’s surprisingly meditative white-marble conference suite in a room overlooking the Hudson River’s North Cove Yacht Harbor just below Vesey Street.

Balkan, 54, may prefer more stationary assets. But $7 billion can buy a whole lot of yachts.

Commercial Observer: The most obvious thing that sets Brookfield apart as a lender is that it’s also a gigantic landlord. How does that color your work?

Andrea Balkan: The number one way is the fact that we have great access to information and real-time data. This is one of the most collaborative organizations there is. Anytime we’re looking at a deal, there’s somebody I can call to ask detailed questions about the market, so we can immediately get information. That’s been the biggest difference between being at a bank and being at Brookfield—that I can get equity-side information immediately.

Can you give me an example of the sort of info someone from Brookfield’s equity side might be handing you?

Our lending group does appraisals like everyone else, but an appraisal is giving you data on everything that’s happened up until now—or, really, up until three months ago. With access to an actual landlord who’s in the market, you can understand what’s happening now. What do tenants want in this market? Who is moving out of the market? Before the credit crisis, we had the opportunity to get involved in a loan in Seattle—I can’t give too much detail, because we said no to the deal. It’s not a market that Brookfield was invested in at that point, so we went out there and we met with a number of leasing brokers in the market, which our Brookfield equity team helped set up. And what we discovered was that the building we were looking at wasn’t where tenants wanted to be. They were there because they’d signed leases three, five or 10 years before. So we knew this probably wasn’t the right risk for us.

So it’s about getting a kind of “behind the numbers” view?

Yeah, exactly. If we’re looking at an office building in New York where there’s some ground-floor retail, I can get a sense [from Brookfield’s equity business] of what tenants think about the location. What are people paying today in rents? How should I be thinking about it? The borrower says they’re going to earn X dollars per square foot in revenue—O.K. But we own other buildings in the market. Is that realistic? It’s a way to test assumptions.

That Seattle story is fascinating because it seems to me that most mezzanine lenders would love to be lending on a fully occupied big-city office building—even if leases are rolling over. Would you say you’re (in general) looking for properties that are in the transitional space, with more upside?

Absolutely. We want good real estate. And we’re very comfortable with transition, and very comfortable with complexity. Fundamentally, we want to lend on really high-quality assets at a basis below what we’d consider intrinsic value. You actually hit on something we were just talking about yesterday: We’re very cautious about assets that have stable cash flows. I think to some extent, lenders overvalue existing cash flow. What do you need to do in terms of tenant improvements to re-lease it? O.K., the cash flow is nice, but how much did you spend to get that cash flow? That’s key for us.

You have a banking background, correct?

I started in Chemical Bank’s credit training program, which was eight months of doing kind of a mini business school. I then spent 12 years at Chemical doing a lot of different things: lending, workouts. Then I got involved in the mid 1990s at Chemical in their securitization business—or, well, involved in starting it, because securitization was pretty new in real estate then. 

Had you studied real estate in college?

I went to college with a liberal arts major—history—at Wesleyan University in Connecticut. I think that’s a great background. It teaches you how to think, adapt and take risks.

What was next for you after Chemical?

About 1998, I was ready to make a move. Merrill Lynch approached me, and I went over there to co-head their conduit operation. But after a few years there, I really felt like it would be more interesting to be able to make loans that we would keep and see through the whole life cycle. [My colleague] Barry Blattman and I knew Brookfield was interested in starting up a formal mezzanine lending business, and we started talking to them.

Had Brookfield done any mezzanine lending before you came on?

Brookfield had always been an opportunistic investor for their own balance sheet. If they saw an interesting piece of debt, they would buy it. So what we pitched to Brookfield was that we thought there was a great opportunity in a mezzanine lending [fund]. If we could marry up Brookfield’s real estate expertise with our debt structuring expertise, we could create a great business.

Can you take me through the trajectory from there?

We raised our first fund in 2004, which was a $600 million fund. Brookfield invested a third of it, and the other $400 million were large institutional investors. Fast forward and we’re now on our fifth mezzanine fund, which is really in our flagship style: 60 percent to 80 percent loan to value, on more transitional assets.

Interesting. I’ve seen plenty of deals lately where the senior leverage is itself creeping up to 70 percent LTV. Does that trend cut into your slice of the pie, if you’re not willing to exceed 80 percent?

It can. But ideally, we want to be 10 percent to 20 percent of the capital stack. That’s our goal. So that might narrow it down—but probably just about to the 10 percent level.

How does this work in practice? Can you give me a real-life example?

One deal we did recently was 116 John Street in Manhattan: a multifamily loan down in the Financial District with a repeat borrower of ours. [Metroloft, a New York City residential landlord, owns the fee interest in the tower.] The borrowers were looking to refinance, and we took down the whole loan. It was a $170 million whole loan: We sold a $130 million first mortgage [to insurer AIG, as per deal sources] and kept a $40 million mezzanine piece. It was a stable, operating multifamily property, but the borrower had the opportunity to get increased cash flow out of the property by putting in a co-living tenant. We understood it. And we were able to provide the loan with that transitional element. 

Is that approach typical for you—taking down the whole loan and then selling off the senior portion?

Absolutely. Another good example—a $427 million loan we did on One Dag Hammarskjöld Plaza. We sold a first mortgage for $365 million [Wells Fargo bought it, the bank announced at the time], and we created a $62 million mezzanine loan. Our last-dollar basis was around $500 per square foot. It was an institutional borrower, and there was a little bit of lease-up. [The loan helped Rockpoint Group buy the Midtown office tower from the original developer, Lawrence Ruben, late last year.] We’re finding a lot of really great opportunities in New York. 

Why do you attack the market from that direction, as opposed to taking on the mezzanine piece of a financing that a senior lender spearheads?

Everybody’s got a different strategy. There are some lenders who are more focused on buying a small mezzanine loan, but that’s not so interesting to us, because then, you’re buying the debt retail. Once in a while we will team up with a senior lender. But we’re not so interested in buying at auction. Another one of the biggest differences between us and everybody else is that we don’t use repo financing. Some people will take down the loan and finance it with a repo facility from a bank. I attribute [our unwillingness to do] that to our having been doing mezzanine lending for a long period of time. 

So you used to have an appetite for repo, but don’t anymore?

Yeah. Having been here before, during and after the credit crisis, and watching the way repo got handled by banks, we just think it’s a risk we’re not willing to take. With a repo facility, two things happen. Number one is that the bank actually owns your whole loan, and you have the right to buy it back. They’ve got some leverage. And repo also generally has mark-to-market margin callability. So when the market goes down, the bank can margin call you. That’s not a risk we want our customers to take. We saw a lot of people get a lot of margin calls during the crisis. Also, when you’re taking a repo, a bunch of your assets are all cross collateralized. It’s recourse. When you sell a first mortgage, it’s basically non-recourse. When it’s repo, your whole fund is on the hook for each loan.

The group of lenders who are out there buying your senior debt—how has that list of names changed over the years?

It’s changed dramatically. Prior to the credit crisis, senior lenders looked at mezzanine as additional risk. I think that after watching how mezzanine lenders handled themselves during the crisis, they now actually see it as an additional layer of protection. We’re kind of a buffer. During the crisis, we always used to tell senior lenders, “You should want us in the capital stack, because we’re there to protect the lender.” Now, they believe it.

What percentage of your business is in New York?

In our flagship fund, 13 percent of our total commitments are in New York. And 33 percent is still unallocated, so that would gross out to about 20 percent of what we have committed.

What markets elsewhere have gotten the majority of your attention?

We like gateway cities. We’re really focused, and we want to be in markets where there are barriers to entry, where we can be below replacement cost. We do Washington, D.C., Los Angeles, San Francisco.

Thinking about your role as a transitional lender, are there any business plans that you steer clear of?

There’s no one thing. We’ll even do construction loans. But if we’re going to do a construction loan on for-sale housing, we want to make sure we’re in at a really good basis. Listen, if the deal doesn’t go right, there’s going to be basis creep. If you take over the asset, you can say, “I’m thrilled to be in at $1,000 per square foot, because the market’s at $3,000 per square foot.” But if you end up owning it, between paying interest on the first mortgage, and carrying costs and sales costs, you’re not going to be at that basis for very long. We’re very conscious of what our basis is. 

I don’t speak with so many lending executives who’ve been in the same organization for 17 years. What was your debt funds’ experience of the financial crisis like?

We had a lot of loans on our books at the time. But one of the nice things was that we also had a lot of capital, and we were prepared to do what we needed to do to protect ourselves. We could get decisions made here immediately. The biggest problem with CMBS is that you can’t get a decision made. If there was something we wanted to do to put our investors in a better position, I could call my investment committee within 24 hours and people would get on the phone and make a decision, no matter where in the world they happened to be. That’s a big difference.

You mentioned that you live in Westchester the last time we spoke. As a New York City-area local, what’s the city’s most important real estate story today?

I think the retail experience in New York is phenomenal, better than it’s ever been. I think you have so many more options here [near the World Trade Center.] You can get food, clothing, electronics, everything. In downtown Manhattan! You could never get that before.

Do you wind up talking real estate with your family when you’re just hanging out in the city?

Yeah! When my kids come into the city with me, [I say to them], “Hey, we made a loan on this building! Hey, did you know Brookfield owns that building?” And so it’s really tangible to them.

I’m sure they’ll grow up to be pros. Would you encourage them to make a career of it?

I’ve got three—one’s 20, one’s 17 and one’s 14. If they were interested, I think real estate is great. It’s a combination of the best of banking and finance with a more hands-on experience. I would advocate for them to go in, either on the debt side or the equity side.