The Greenbriar at Saddle Rock Apartments in Denver is getting $1.8 million in fresh paint and improvements, thanks to an acquisition and rehabilitation loan funded from the sale of collateralized debt obligations (CDOs), a relatively new financing tool that can bring Wall Street dollars to fund commercial real estate loans with shorter terms.
The seemingly insatiable appetite of Wall Street investors for real estate has meant low interest rates for permanent loans sold to investors as commercial mortgage-backed securities (CMBS). But CMBS investors have shown little interest in buying short-term loans smaller than $50 million.
CDOs are more flexible. Both CMBS and CDOs pool loans that are then sold to investors, with different sets of investors buying different tranches of risk. But a loan pool freezes the moment it is sold to CMBS investors. A borrower that wants to prepay has to replace the loan in the frozen loan pool with something just like it, using defeasance or yield maintenance.
CDOs are much more fluid; loans can enter and leave the pool long after the initial sale to investors. That makes prepayment much easier. It also means that CDOs can fund much shorter-term loans. “CDOs are extremely flexible,” said Charles J. Foschini, a mortgage broker for CBRE/Melody.
The typical apartment loan funded with CDOs can be as small as $5 million, has a term of just three to five years, and, depending on the property, has a floating interest rate ranging from 130 to 250 basis points over the London Interbank Offered Rate (LIBOR), the typical benchmark for such loans.
New life for the Greenbriar
The floating rate on a CDO loan can also be swapped or capped so the loan behaves more like a fixed-rate transaction. For example, the loan for the Greenbriar Apartments was initially structured as floating-rate debt priced at 130 basis points over LIBOR. Bascom Group, LLC, which purchased the property, then paid 40 basis points for a rate swap that gave it a five-year, fixed-rate loan at 180 basis points over the yield on five-year Treasury bonds.
The purchase and renovation of the Greenbriar will cost Bascom Group a total of $34.2 million. To complete the work, the firm took out a five-year, $27.6 million loan arranged by CBRE/Melody and funded with CDOs. That will cover 79 percent of the development cost with a debt-service-coverage ratio of less than 1.0x.
In the past, deals like these relied on higher-interest loans from balance sheet lenders like banks or large credit companies such as General Electric. Also, the banks typically offered recourse loans, which allow them to claim the personal assets of the borrower as collateral if the loan defaults. These loans often charge borrowers an additional point in upfront fees.
Like most CDO transactions, the loan to the Greenbriar was non-recourse and had no upfront fee, said Brian Eisendrath, who arranged the financing for Greenbriar. Eisendrath is a director for CB Richard Ellis Capital Markets.