American Campus Communities uses mezzanine financing as a means to acquire new product without building it itself, like The Retreat, located in San Marcos, Texas.
PHOTO: Johnny Stevens
When Austin-based American Campus Communities (ACC) jumped into the mezzanine financing pool two years ago, it was a no-brainer.
But its approach is rather unique in a market where mezzanine financing is less of a necessity thanks to more available equity options. For ACC, the financing is purely a means to ultimately acquire real estate that meets their investment criteria.
“We want to acquire quality product at close to development yield without taking the development risk in the investment,” says William Talbot, ACC’s chief investment officer.
Talbot adds that the company has no annual volume goal to issue a certain amount of mezz; it simply wants to acquire new product without having to build it itself. But ACC is just one of a small but growing number of developers offering mezzanine financing as a way of finding more yield and new opportunities.
ACC's mezz generally prices at the lower end of the market, offering a 10 percent interest-only, compound payable monthly rate. It’s attractive for developers, relative to what's available on the open mezz market, where pricing hovers between 12 to 15 percent.
The lower rate isn't just a better deal for the borrower, it's a win-win all around.
“The ultimate goal of the program is to allow the developer to develop a project at the lowest cost basis, which allows us to buy it at a lower basis,” Talbot says.
In exchange, ACC has a pre-sale obligation on the asset, leading the project's marketing and leasing efforts, which alleviates the developer of operational risk.
But ACC isn’t alone in the game. At Dallas-based Behringer Harvard Multifamily, executives have implemented a mezz program complementary to its equity investment program. And its been doing it for more than two years now.
“Sometimes, something about the structure or location of the property doesn’t allow for traditional program, which is where the alternative mezzanine financing comes in,” says Mark Alfieri, president and chief operating officer at Behringer Harvard Multifamily REIT I.
They provide financing for up to 88 percent of costs, requiring the developer to put up at least 12 percent equity. Its been offering the same mezz rate for two years at a non-negotiable 15 percent, and have done several deals in light of the higher price.
Developers like ACC and Behringer Harvard offer steadfast rates, and are also steadfast in who they invest with.
“They have to be projects that we can kind of keep an eye on and visit when we’re visiting properties in our existing markets,” Alfieri says. It has to be consistent with the rest of its portfolio for Behringer Harvard to be interested, located in a top-tier coastal or Texas market.
“The first question that I ask is it a property that we would like to own?” he says, although there’s no outright plan to acquire it after providing financing, like ACC.
Because of ACC’s goal of acquiring the asset on which it lends, the company has a strict guideline for the projects that meet their investment criteria.
“In the world of student housing, at ACC, that means proximity to campus,” Talbot says. “It’s got to be pedestrian friendly and close to a tier-one university.”
The majority of partners they work with are merchant developers who want to sell the asset anyway. So ACC takes the disposition side risk out of the deal, and they get compensated by purchasing it closer to a developer yield than an equity one.
It's all about providing the merchant developer with a clear exit strategy with no lease-up risk.
“So for a merchant developer that wants to get into student housing and is attracted by the yields and the demographics and the investments, but doesn’t want to put all their value into third-party managers hands, or invest the capital and build up to a platform to be able to manage it themselves, this is very attractive,” he says.
Although the developer doesn’t get the full market cap rate when it sells, the deal makes sense for them when you look at the risk-adjusted returns, Talbot adds.
Still, the stable rates on mezzanine financing reflect the fact that demand isn't too high at this stage in the market cycle.
“To be honest, I think the demand for mezzanine has waned a bit, since more equity is coming into the market,” Alfieri says.
Behringer doesn’t see as many opportunities as it did a year ago–with a 15 percent rate, developers aren’t flocking to get mezzanine financing given today's low interest rates on construction loans and the wider availability of equity.
But it’s been helping Behringer on its road to build up the portfolio in tandem with its new construction pipeline. But unlike new construction, mezz financing offers cash flow and returns on equity that a developer traditionally won't get until the development is filled and leased.
“We’re supplementing our very substantial development pipeline with mezzanine financing,” Alfieri says.