As interest rates on permanent loans continue to bump up, prices on mezz financing are slowly inching down. In general, mezzanine debt is being priced in the 11 percent to 14 percent range, about 150 basis points (bps) lower than this time last year, and about 350 bps lower than in early 2009. Most stabilized assets will find rates around 12 percent, while transitional properties are seeing rates closer to 14 percent.
“What's driving the lower rates is the desire to deploy capital, the lack of transactions, and the fact that senior mortgage interest rates are very low,” says Dave Valger, managing director for New York–based mezzanine and bridge loan provider RCG Longview.
RCG Longview is one of a number of companies finding new avenues into and around the mezz financing arena, each boasting terms and features that will likely make mezz a more palatable execution in the near future.
The company, which expects to see increased mezz demand this year, provides the mezz piece for Fannie Mae's DUS Plus program. The revamped DUS Plus has been tweaked from its previous incarnation and now maxes out at an 80 percent loan-tovalue (LTV) ratio, whereas it once went up to 85 percent. The program also offers a 1.10x combined debt service coverage ratio (DSCR).
While demand in the Fannie Mae program has been lukewarm thus far, RCG is looking to drive mezzanine production in other ways. At the end of 2010, the company started originating whole loans for the purposes of securitizing the permanent debt and retaining the mezz piece on its balance sheet.
RCG Longview's entrance into the securitization market has already netted a few multifamily deals, including a $23.6 million loan on four properties in Ohio and a $17.2 million deal on a 260-unit property in Novi, Mich. “We knew there were many properties that needed more leverage than CMBS could provide, and there was a significant number of lenders originating both pieces separately,” says Chris LaBianca, president of RCG Longview Debt Fund IV. “That process is often more cumbersome, and more expensive, for the borrower."
The company's new program targets stabilized, cash-flowing assets, and for multifamily deals, RCG is willing to go into secondary and tertiary areas. The new program offers a combined minimum 1.15x DSCR, with all-in rates in the low- to mid-6 percent range as of mid-February. The maximum LTV offered by the program is around 80 percent.
Meanwhile, Philadelphia-based mezzanine provider LEM Capital also recently rolled out a new program, called “Preferred Plus,” to help drive production this year.
Unlike the company's traditional mezzanine debt program—which provides financing subordinate to senior loans up to 85 percent LTV—Preferred Plus offers preferred equity and funds the portion of the capital stack above the first mortgage up to 95 percent of LTV.
One of the program's key features is that there are no required monthly payments— all payments are based on available cash flow. “I don't think people want to have the debt risk right now with mezzanine— having coupons at 12 percent that you have to pay every month is difficult for people to swallow,” says Herb Miller, a partner at LEM. “Borrowers are looking to figure out ways to bring in equity that doesn't have the debt risk, and that's why Preferred Plus works pretty well."
Basing all payments on cash flow also opens up more business opportunities for LEM—senior lenders can count Preferred Plus as new equity instead of senior debt. For borrowers, the promote structure offered by the program is more favorable than a traditional equity arrangement—sponsors get a bigger upside, a bigger “promote,” and more potential for profits. But the trade-off is that in the capital stack, LEM is senior to the sponsor's equity.
The company is looking for deals in which it can finance between $5 million and $20 million, though it will go higher or lower on a case-by-case basis. Terms for the program run from three to seven years and generally include a 10 percent to 15 percent preferred return paid from cash flow and some equity participation feature.
LEM doesn't expect to see a lot of demand for traditional mezz debt this year— last year, the company didn't close any mezz deals for multifamily properties.
Freddie Mac expects bigger things from its mezz program this year, for which it partners with Berkshire Properties, Carmel Partners, Essex Property Trust, and Waterton Capital Solutions.
Like Fannie Mae, Freddie Mac revamped its mezz program in the second quarter of 2010, but it only recently closed the first loan through the program. The loan, for the 397-unit Metro Place in Camp Springs, Md., consisted of a $47 million first mortgage combined with a $6.75 million mezz loan through Berkshire Properties that brought the total LTV ratio up beyond 80 percent.
Last year's historically low interest rates tempered the need for mezz financing, but as all-in rates continue to climb, it's much more difficult for borrowers to maximize proceeds.
“When we rolled the program out in the mid-part of last year, rates just continued to go down, which generated more proceeds on a first mortgage basis. That stole a lot of the business,” says Mike McRoberts, vice president of multifamily production and sales for McLean, Va.–based Freddie Mac. “But we're looking for that to turn around now with rates starting to pop back up."
Defensive refis will likely drive more mezz production.
MEZZ PROVIDERS RCG AND LEM have both seen more requests for “acquisition-rehab” deals of late, but they're much different from the repositionings done at the height of the last cycle. The common thread today is a need to cure deferred maintenance, or bringing down units back on line.
Dave Valger, managing director for New York–based RCG Longview, says he sees a growing need for defensive refinancings given the higher permanent loan rates and the continued wave of loan maturities this year. About $155 billion in commercial real estate loans will come due this year—and that's only counting “nonbank” lenders such as the GSEs and life insurance companies, according to the Mortgage Bankers Association.
“In 2011 and 2012 is when you see the bigger stuff coming due, and there has to be a lot of equity around to re-equify that stuff,” Valger says. “We anticipate that this is going to be a much better year for originating the kind of loans we're looking for."