Beyond Banks and Life Companies

By: Riaz Cassum, Holliday Fenoglio Fowler L.P.

While commercial banks and life companies continue to dominate the limited volume of commercial real estate lending currently taking place, new lending sources are beginning to emerge to replace a portion of the liquidity formerly supplied by the now dormant CMBS market. The three vehicles most often used to raise this new capital are (i) private/non-traded REITs, (ii) publicly traded mortgage REITs and (iii) private equity debt funds.

Private/non-traded REITs have been raising funds using retail broker-dealer networks at an ever-increasing pace. Small investors, drawn by the promise of stable returns with limited principal risk, have poured billions into private/non-traded REITs such as KBS, Dividend Capital, Cole and Behringer Harvard.

Publicly traded mortgage REITs, which were last popular in the 1970s, are making a comeback. Starwood Property Trust most recently raised $950 million via a public offering. Other mortgage REITs planning on raising capital in the latter part of 2009 include Apollo Commercial, Transwestern, Brookfield, Colony Capital, Ladder Capital and CreXus. Mortgage REITs have garnered investor attention because they provide significantly greater liquidity and transparency and require a smaller minimum investment than private equity debt funds.

Lastly, given the favorable relative risk-adjusted value of debt investments to pure equity plays, private equity fund managers have had recent success raising capital for new debt funds or redeploying existing funds into mortgages. This capital has come from the same sources private equity funds typically tap, including pension funds, endowments and high-net-worth individuals. 

While each of these vehicles has a somewhat different strategy and return parameters, all three sources are looking for stable long-term debt investments and are offering five- to 10-year, non-recourse deals with rates in the 8 to 9 percent range for loans up to 75 percent of value. In contrast, life companies are limiting their lending to 55 to 65 percent of value, with rates ranging from 6.5 to 7.5 percent. These loans are best for office, industrial and retail projects with significant term remaining on leases, as the stability of the cash flow is paramount. In addition to traditional first mortgages, most of these lenders will also write B notes and make mezzanine loans up to 65 or 70 percent of the property’s value. Rates for mezzanine loans can be as low as 10 percent but more often are in the 11 to 15 percent range. In return for additional yield, some lenders will consider loans on hotel properties and acquisition financing for note purchases.

All three sources are targeting borrowers with short-term maturities and plan to hold these loans on balance sheets. Some lenders may explore securitization exits for the senior investment-grade portions down the road. The publicly traded REITs and private/non-traded REITs will be more anxious to deploy this newly raised capital in a timely manner in order to meet investor dividends. Private equity debt funds, by virtue of their institutional investor bases and longer investment horizons, are not under as much pressure to make investments in the near term.

The formation of new debt capital is an encouraging sign in what has been a capital-starved real estate market.  Expectations are high for all three of these vehicles to contribute much needed liquidity for the avalanche of maturing loans over the next several years.

Riaz Cassum is an office head in the Boston office of Holliday Fenoglio Fowler L.L.P.