Capital Partners: How Berkadia’s Noam Franklin and Chinmay Bhatt Deliver Equity, Debt

This conversation has been edited for length and clarity. 

Commercial Observer: I imagine a lot of capital coming into the multifamily sector because so many deals in 2021 and 2022 used floating-rate debt. What are we seeing happen to rightsize these capital stacks?

Chinmay Bhatt: There’s a lot of interest in mezzanine and preferred equity, and less interest in JV equity because capital wants to be in more of a protected position today. Often we’ll run a process and, even if we’re not asking for JV equity, we’ll get some JV equity options, but we also get folks who say, “We’re not a player in the common equity space, but would your client take any preferred equity or mezzanine loan options here?” Sometimes the client is open to this, and it all comes down to the structure and cost of that capital, but other times they’re looking for common equity executions. What we’ve seen over the past two years is that capital has been more cautious, and because of that cautious approach, they wanted to put out more preferred equity and mezzanine loans. There’s a lot of dollars chasing that type of execution, but there’s not enough deal flow. We heard recently from groups who told us they put out 30 or 40 offers for preferred equity, and they only closed one or two deals, because a lot of other people are offering that solution to owners and developers and you have to bid into that process. 

How has that impacted pricing? 

Bhatt: Risk is hard to price today, just with all the different uncertainties and the volatility going on in the market. So on any individual deal, in preferred equity or the mezzanine space, we’ll see a wide range of pricing: 200 to 300 basis points-wide options coming in from capital. It’s the same deal, the same leverage point, they’re just looking at it differently. Part of that is the source of capital [and its unique attributes]: do they have dedicated source preferred equity? Or a mezzanine bucket of capital? Or are they pulling out of their general fund that tends to have a higher hurdle for returns? So, it’s determined by where that capital is coming from and their view of the risk in the deal. Folks like us add a lot of value, because if we’re able to push down the cost of capital for a client by 2 or 3 percentage points per year, that will matter on a multiyear execution.  

How often are you connecting with equity sources? Who are they?

Noam Franklin: We spend all day talking to equity sources. They’re institutional family offices, private equity funds, life companies, endowment funds, sovereign wealth funds, pension funds, we’re speaking to the whole gamut of capital. The other benefit is we have a strategic alliance with Knight Frank that Berkadia announced a year ago. For Chinmay and myself, the benefit of this is we talk to the international capital every day now, usually early mornings. We get on a call with Knight Frank’s office in Berlin or Dubai, and they say, “We have a client in the market who wants to look at U.S. opportunities.” So we’re really getting a good overall feel of what global capital wants to do in the U.S.

Can you give me an example of the type of deals you’ve been working on? 

Franklin: We just capitalized a development deal in Grand Prairie, Texas, a Dallas suburb. We were told to go find preferred equity partners for the transactions, and we couldn’t believe what we were seeing. Some groups would price it [at a certain basis], and at the same leverage point, other groups were 300 basis points wide of where the business was won. It’s a bit of the Wild West in terms of capital throwing out terms. We ask most of these groups, “How much preferred equity or mezzanine debt have you deployed in the last 12 months with this strategy?” and, realistically, very few of them have done anything in that space. They tell us they put out terms sheets, but a lot of these deals die. 

Is all this new money going towards refinancings or other types of capitalizations?

Bhatt: It’s various types of deals. One type of deal is if someone is refinancing, and the new loan isn’t sufficient to pay off the old loan, there may be a gap that needs to be closed, or someone is recapitalizing their existing equity piece. So, for example, existing investors in the deal have owned it for a while, but are now looking for an exit. We can bring in a new capital source to continue the business plan. So the market is pretty active in the new development projects as well as in the acquisitions space. We’re actually seeing the acquisition space really heat up. Clients are bringing us deals where they’ll buy either through the market, or off-market, a property they don’t own yet, or on the development side, they need new investors to build multifamily across the country. 

There’s  a lot of overlap between mezzanine debt and preferred equity. How do they differ?

Bhatt: There can be a vast difference because it’s what you negotiate at the end of the day. Typically, mezzanine loans tend to be a higher level of involvement between the senior lender and the mezzanine provider because they need to have intercreditor agreement between each other, outlining how the senior lender and mezzanine lender will say to each other, “Hey, you’re the senior lender, and you recognize we’re the mezzanine lender, and here is what we can do under different scenarios when something goes wrong with this project, i.e. you give us this ability to right the ship,” and this entire legal process can be onerous, especially if it’s a lender which this mezzanine provider hasn’t done a deal with before.  

The other thing, in a mezzanine loan — and this isn’t always the case — is the rate of the cost is usually paid current. Meaning this: If it’s a development project, for example, there’s no cash flow in the early years, so you need to build in an interest reserve for a mezzanine lender to get paid their coupon. If it’s an existing asset, whatever cash flow comes off that asset must be able to pay the coupons for that mezzanine loan. 

For preferred equity, while there will be an understanding between the senior lender and preferred equity provider that, “Yes, we know each other, we’re in this capital stack together,” there’s not an onerous document like the intercreditor agreement governing that relationship. So that obviously saves time and dollars. But the other thing, with preferred equity, is we have greater ability to accrue the coupon versus paying it current, and we can do fully accrued deals, i.e., for development projects, when there is no cash flow, the investor can say “I can accrue this, until you start getting cash flow or sell the property,” or we can do something in between, where half of coupon is paid current and the other half is accrued [built up over time]. You usually have a little more flexibility on the structure of the payment with preferred equity versus mezzanine loans, but everything is a negotiation. 

Noam, you had hinted a moment ago about global capital entering the U.S. Where is this capital going?

Franklin: The two of us have been abroad six or seven times now since 2023, so we can speak to a lot of different regions. The one region of the world we meet with — where we view they really like the U.S. right now and and they want to take opportunistic risk — is Japan. Japanese investors have  been in the U.S. Historically, they understand the U.S. markets to some extent, and we found that they want joint venture equity risk, they want development risk, they want to be in partnerships with best-in-class developers in this country. They want to do development. That was the only region we traveled to outside of the U.S. where we thought they’re really bullish on new development. 

Until two years ago, the market here in the U.S. was so hot that most developers said, “If you have a site that pencils, and it makes sense, we can pick up the phone and have 10 JV equity partners and one will give us a term sheet, so why spend time talking to capital outside the U.S? There’s cultural differences to get around.” Now, there’s so little joint venture equity in the U.S. for development that Japanese capital is saying, “Hey, this is our time to get into programmatic relationships with the best developers across the country.” 

The other thing worth mentioning is the Middle East. What’s going on in the Middle East is all those markets, Saudi, Dubai, Abu Dhabi, they’re doing really well. Their view is “I can invest in my home markets on the development side or the value-add side for returns. It’s a market I know, and there aren’t any time zone issues.” Their view is that if we invest in the U.S. today, we need outsize returns to go there. But it’s hard to find outsize returns in the living actor. So they love the U.S., they continue to look at the U.S., but what they need is day-one, double-digit, cash-on-cash returns for multifamily assets. And we’re not finding many deals that do that. Until that happens, their view is we’ll keep looking, and maybe we’ll put out terms in preferred equity or mezzanine debt, but we haven’t seen them very active in the last 24 months here in the U.S. 

What’s  it like to broker capital between U.S. developers and sponsors and these faraway sources of capital on the other side of the world? 

Bhatt: One thing we’re really educating our clients on is the sophistication level of capital outside the U.S. It’s very high today. They’ve really come up the curve in terms of their understanding of the market, how to structure deals outside of the U.S., how to work with developers and operators here. Especially with larger family offices and institutions, you’ll find many have folks who’ve worked in London or New York or L.A., and have strong experience. I like to joke that sometimes we get term sheets from them and they look like term sheets we usually get from a major fund and only the logo has changed from Goldman [Sachs].  The folks now running real estate practice at these [foreign] firms have that experience base, that mindset, so they’ll apply the same process and due diligence [to deals]. 

And when they lock in, when our clients spend time to build that relationship, they see a lot of value. We call it a dating process: It’s a little lengthier when someone is sitting in Tokyo, Shanghai or Dubai. But once we get through that process it tends to be sticker capital, so that’s an important message we’ve been delivering here for a few years. The sophistication level is there. 

Let’s talk about interest rates. We’ve had a couple of cuts from Fed Chairman Jerome Powell. What’s going to be the impact of those cuts on the living sector?

Bhatt: You won’t see some direct impact, but what we’re hearing from capital providers, and capital markets in general, is uncertainty is usually one of worst things for investors — what you don’t know, you can’t plan for, you can’t underwrite it, and you can’t account for it. So what we’ve had in the last 18 months is a lot of uncertainty in the market. Politically, it’s election season, the rate environment went up and no one knew when it came down, and obviously geopolitics plays a factor. But what we’re hearing today is, slowly but surely, you’re getting some uncertainty under the table. The Fed has dropped rates for the first time in quite a while. What a lot of capital is telling is that we’re getting increasingly excited about the market. The senior decision-makers at these firms, whether they are family offices or funds, no matter where they’re based, say, “It’s harder and harder to remain pessimistic today.” And to be optimistic you first have to stop being pessimistic, so I think we’re at that important transition period right now. 

Which asset class in the residential  sector will benefit the most from debt and equity movements now that we have this clarification on interest rates?

Bhatt: More and more, we’re seeing that even capital that in the past might not have focused on multifamily, is focused on U.S. multifamily. Capital out of Asia doesn’t have the equivalent asset class, so they have to come up to curve on multifamily in the U.S. and the agencies here that provide financing. But we work with a lot of capital where we bring them up to speed on their knowledge base where they are now saying, “We’re very interested in multifamily in the U.S. and, yes, we understand it’s a large and deep pool of properties with institutional capital coming.”

Franklin: We’ve been talking every 30 minutes with large private equity funds, and what we’re finding is there’s a lot more optimism. Earlier in the year, if I’d met with a private equity fund and I asked, “What have you closed?” The answer was “Nothing.” In San Diego, last week was the first time we caught up with relationships where they actually had actual stuff, three joint venture value-add deals. And on the development side, a lot of capital tells us that no one is doing anything in that space, but we keep pushing back. Our team has closed five development deals since April. People are doing things, but we had to look at 1,000 deals to get those five across the finishing line. The point is development isn’t dead, it’s just much more difficult to get a JV partner on board today.

Brian Pascus can be reached at bpascus@commercialobserver.com