AS BANKS AND OTHER institutional lenders scale back their balance-sheet lending appetite, it's getting harder to find mezzanine financing.

Developers who can locate mezz financing are finding it much more costly today. Mezz lenders are now offering rates between 14 percent and 17 percent, up from 11 percent to 13 percent a year ago.

Life insurance companies and banks are reserving balance-sheet loans for only their strongest borrowers—those with whom they have a deep relationship. So lenders who specialize in mezz financing now have the market mostly to themselves, according to Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop, a commercial real estate lender focused on multifamily.

New Players

While smaller mezz providers, such as Short Hills, N.J.-based Mezz Cap and Philadelphia- based LEM Mezzanine, are still in the game, the most active mezz lender today may be New York City-based RCG Longview. In fact, RCG Longview closed a $602.5 million mezzanine debt fund in February and will likely target about half of it at multifamily borrowers.

RCG Longview will favor stabilized assets in primary markets, a shift from the standard acquisition/rehab deals that the company was focused on in rosier times. Today, the company sees opportunity in properties with significant deferred maintenance, where the financing could be used to improve the asset's operating performance, either through lower costs or higher occupancies.

“The standard mod/rehab business model doesn't work as well anymore,” says David Valger, a director who runs RCG Longview's multifamily debt division. “But there are opportunities for us in properties with deferred maintenance, so that you're not underwriting a bump in rents but a significant improvement in performance.”

Cash-in refinancings will also be a focus of the new fund. Many owners with maturing debt will need to recapitalize their properties this year. But senior mortgage lenders, such as banks, life insurance companies, and Fannie and Freddie, are underwriting at tougher terms now, constraining proceeds and ultimately contributing to the need for more debt to bridge the gap.

The higher mezz rates in the market reflect the additional risk from uncertainty and continued erosion of market fundamentals that many areas are facing. Consider that capitalization rates for Class A properties may move to 7.5 percent or 8 percent; Class B properties may move to 8 percent or 9 percent; and Class C properties may hit more than 10 percent in the next year or so, according to Valger. “The pricing is indicative of the kind of spread in values you're seeing today,” Valger adds.

Underwriting standards have also gotten tougher. In the past, RCG Longview would underwrite at below a 1.00x debt service coverage ratio (DSCR) with reserves. The company would anticipate that additional cash flows would bring the property into a positive DSCR range. But now, the company is more likely to underwrite at a breakeven and higher DSCR.

RCG Longview partners with Fannie Mae, providing mezz debt on the CI Mezz-Mod Rehab and DUS Plus programs. The volume of Mezz-Mod Rehab deals has slowed considerably over the past six months as lenders favor stabilized assets over transitional deals. But the DUS Plus product, which combines mezz debt with a Fannie Mae permanent loan for conventional properties, has seen more interest lately, especially for cash-in refinancings.

Alternate Approaches

Some institutional lenders are partnering with other capital sources to keep the flow of mezz loans available to their clients. Prudential Mortgage Capital Co. has partnered in the past with pension funds and foreign insurance companies on co-investment activity and is actively exploring such partnerships today.

“Mezzanine and bridge-type loans are not something we're programmatically doing,” says David Durning, senior managing director of originations at the Newark, N.J.- based firm. “But there are some avenues that we're pursuing that may bring us additional investor appetite for that space.”