Multifamily borrowers looking for mezzanine financing will again have a crowded field of lenders to choose from in 2007.
A flood of recent entrants, including conduits, banks, and life insurance companies, has lowered the cost of mezzanine financing and made lenders increase their flexibility for the types of transactions they’ll consider.
With low interest rates and tighter yields in the debt market, many senior lenders now are adding a small piece of mezzanine capital to large transactions in order to offset yield losses on the senior debt piece and increase their overall return.
“Funds and institutions who were traditionally senior lenders started opening mezzanine funds as an option to their clients and also in recognition that a mezzanine-type loan earns higher yields,” said Dave McLain, a principal at Fort Lee, N.J.-based lender Palisades Financial, LLC.
The market for collateralized debt obligations (CDOs) also continues to grow, making cheaper money available and allowing many lenders to price their mezzanine more competitively and still earn a nice spread, McLain said.
And as the condo conversion market cools, there’s more focus on multifamily as an investment class. Some funds are “so anxious to get dollars out that they’re probably stretching the limits,” said David Abshier, senior vice president and managing director of Columbus, Ohio-based lender Huntington Capital Markets.
“The underwriting standards out there have come down,” Abshier said. “Somebody once told me, you make your worst deals in the best of times.”
Conversely, borrowers looking for mezzanine financing can make their best deals now.
The price is right
While more competition enters the marketplace, borrowers also are more likely to need mezzanine financing these days.
In the last year, there has been a pullback in the amount of risk a traditional senior lender will tolerate for new construction and repositioning deals, raising the equity requirements of borrowers. “Where loans were going out in upward of 80 to 85 percent of acquisition price or value in the past, lenders are now only going to 75 percent or so,” said McLain.
The current market offers favorable pricing for the borrower. For stabilized assets, “We used to be able to price in the high-teens range, and we might even get a profit participation on the back end,” said McLain. Now the balance has swung the other way, he said. “Borrowers with a good project can get a lower teen rate and not have to give up a profit participation.”
For a new multifamily development, Palisades tries to price in the higher teens and up, attempting to reach 20 percent with a mix of about a 17 percent rate, with 2 or 3 points at closing.
While mezzanine loan terms vary wildly from project to project, “In general, we’ve seen mezz priced anywhere as low as 8 or 9 percent all the way up to 14 percent,” said Ronnie Levine, a New York City-based managing director for mortgage broker Meridian Capital Group.
Levine said that more senior lenders, especially Wall Street investment banks, are including mezzanine loans in the capital structure of an acquisition deal to get to 90 percent.
“When we go out for a first mortgage, we can request a 90 percent loan from our first mortgage lender, and they are building the mezzanine piece into the quote,” said Levine. “To get 90 percent financing on an acquisition of cash-flow producing multifamily is really fairly common in today’s market.”
The lender’s degree of flexibility is an important consideration, but borrowers might not find it through securitized money from institutional investors—even though those deals offer the best pricing, according to McLain.
“Once that mezz loan gets securitized, you lose a lot of flexibility, because now you have a servicer involved; you’re now dealing with a voice in the servicing department, a far distance from your project,” said McLain. “If you need modifications, more money, or an extension of time, you’re not going to get it.”
McLain advises borrowers to match the risk-based yield criteria to lenders with comparable appetites. “Look beyond just the pricing of the transaction,” he said. “They need to fit the lender with their project and their organization,” he said.
A stabilized apartment complex, for instance, may find securitized, CDO-backed mezzanine financing the best option. Such a project “shouldn’t have any bumps, and that kind of financing should work well,” McLain said.
“But if you’re in turnaround mode or development mode (something that can’t be assured of cash flow or timing), then you need a mezz lender that can give a lot of flexibility, both going into the project and as the project moves forward,” said McLain.
McLain closed a transaction last year in Montclair, N.J., for new construction on a condominium development where an abandoned department store stood. The construction lender, a Wall Street institutional construction lender, wasn’t ready to close, but the borrower wanted to start demolition work. That same institutional lender had a mezzanine fund that was going to address the project, but they weren’t ready to close without the construction loan closing.
“We agreed to close ahead of the construction lender and provided the funds so the demolition could begin,” McLain said. “The borrower gained about four months on the project before the construction lender was ready to close.”
Getting to know you
In today’s low capitalization-rate environment, the time has never been better to sell a multifamily property. “I talk to people every day who have sold some of their properties, and they say to me, ‘I never would have sold, but I don’t think we’ll ever see this cap rate again,’” said Abshier.
But from the buyer’s perspective, such a low cap-rate environment presents inherent risks; there’s very little wiggle room. “If you don’t get the rent increase, if there’s any kind of an up-tick in the cap rates, then basically you’re out of luck,” Abshier said.
Establishing a relationship and gaining a comfort level with your lender is key in such an environment. “If there is a hiccup, understand that in most cases, the mezz lender controls the assignment of membership or partnership interest,” Abshier said.
Some mezz lenders may have an itchier trigger finger than others—a lender may pull the loan and take a membership interest more quickly than one familiar with the borrower.
“I’ve seen borrowers who’ve done transactions purely out of pricing and then end up regretting it because they’ve had hiccups along the way, and they end up in an adversarial relationship,” said Abshier. “So, just like the mezzanine lender will interview the borrower, the borrower really needs to interview the mezzanine lender.”