Institutional real estate adviser Heitman, LLC, has begun building a structured-finance team aiming to combine senior and secondary floating-rate debt packages to finance value-added apartment turnaround ventures over two- to three-year terms.

Heitman is known primarily for managing equity investments on behalf of its institutional clients, so borrowers tapping the value-add lending program might eventually be able to secure needed cash equity from the same source as well.

Lending, especially for value-added deals, is not an area institutional investors have been very active in lately, acknowledged Stephen Bailey, one of the Heitman debt group’s two new co-managing directors.

Bailey sees Heitman’s plans reflecting increasing interest among pension funds and other institutions in funding whole loans and higher-yielding subordinate loans in particular.

Indeed, just a couple of weeks after Heitman recruited Bailey and lending veteran Gregory Leadholm to build the adviser’s lending operations, finance giant Principal Financial’s real estate group closed a $225 million institutional fund—its first fund squarely targeting senior bridge-type and secondary loan packages for value-added ventures.

Heitman’s structured-finance team and Principal’s fund provide new sources of short-term floating debt for value-added ventures at an opportune time. That’s because the commercial mortgage-backed securities marketplace is souring on these structures, said veteran real estate investment banker Andy Little at John B. Levy & Co.

Heitman is looking for opportunistic borrowers operating in major markets across the country where Bailey and Leadholm have also been active lenders over the years. They are targeting private, entrepreneurial borrowers typically pursuing 24- to 36-month financing transactions in the $20 million vicinity.

The aim is to work primarily with proven “mid-market” operators looking to add value with substantial short-term improvement and redevelopment programs. The underwriting strategy is to focus on an entrepreneurial borrower’s demonstrated operating capabilities as much as the real estate, Leadholm said.

“We’ll target operators and then go where they choose to go,” said Leadholm, who moved over from Royal Bank of Canada, where he was senior vice president and regional manager for the bank’s homebuilder finance unit.

The Heitman team will offer a “one-stop” approach to financing value-added plays, he said. This would include the ability to provide high-leverage structured debt with liberal recourse provisions, along with exceptional speed and certainty of execution, Leadholm and Bailey added.

The financing structure would generally include first-priority debt up to 70 percent of loan-to-cost, with additional high-leverage tranches usually limited to another 15 percent. In exceptional cases, the secondary slice might take leverage up to as high as 95 percent of cost. But that leverage level would be limited to cases where vacancies are very low, condo reversions are minimal, and both population and job growth are strong.

The co-managing directors also stressed that they’ll make every effort to customize these financings for the benefit of mid-sized repositioning teams. At some point that could include having Heitman-managed investment vehicles contribute equity to the same ventures. But first they’ll need to put every possible conflict of interest related to such arrangements under the ethical microscope, the pair cautioned.

Leadholm and Bailey and their new colleagues in Heitman’s debt group anticipate building the team to 10 or so originators and loan servicing professionals over the coming 18 months. With Bailey stationed in Heitman’s Minneapolis office and Leadholm working from the home office in Chicago, their target is to originate $500 million to $700 million in structured-debt financings annually within three years. Heitman currently manages about $2.5 billion in real estate debt assets.

Bailey, Leadholm and associates are now endeavoring to communicate Heitman’s plans to the mortgage banking community, but they don’t anticipate forging any exclusive correspondent relationships. The debt group is also working directly with borrowers who are comfortable negotiating transactions without outside representation.

Heitman’s overall assets under management now exceed $20 billion. The firm just closed its latest commingled investment fund with $800 million in equity (and a leveraged target of $2.4 billion in total investment capacity). Its fund managers intend to partner with operators pursuing value-added ventures across North America.

Not only is the Heitman brain trust responding to opportunities stemming from the recent distress in the conduit marketplace, it also sees banks, a traditional short-term lending source, getting stingier with value-added financings, Bailey said. He and Leadholm believe the regulated banking industry will have to pull back with respect to underwriting these debt transactions, he added.

Executives with Principal’s real estate group apparently concur with that assessment. Managers of its just-closed Principal Mortgage Value Investors fund aim to leverage the $225 million of equity into more than $1 billion in value-added financings, including bridge loans and subordinate debt through mostly floating-rate loans over two- to three-year terms.

“It will allow us to more aggressively seek out quality bridge loans and subordinate debt investments,” Principal Real Estate Investors Managing Director Margie Custis said in announcing the fund’s closing.