Multifamily borrowers are likely to find plentiful mezzanine-type capital in 2005.

Even as the cost of mezz debt and preferred equity is apparently nearing a cyclical low point, investors will benefit from broadened lender targets in terms of venture strategy, deal size, capital structure and even term length, experts said.

Given all the new mezzanine funds being formed, the heavy supply in 2006 will motivate increasing flexibility among fund managers in the sizes and shapes of transactions they’ll consider, said E.J. Burke, executive vice president at KeyBank Real Estate Capital.

Credible borrowers in most cases should be able to tap the mezz and preferred equity flow to leverage strategic property acquisitions and value-added ventures up to 90%. It appears that plenty of mezz lenders will likewise be willing to boost overall loan-to-cost leverage up to 85% for solid apartment development projects.

“We’ll see a huge supply of mezz and related high-risk capital targeting value-added multi-housing ventures this year,” said Andy Weiss, managing director with lender Meridian Capital Group. Proven players with documented exit plans in place should be able to combine conduit debt with a mezzanine slice for 90% total leverage.

The cost of this capital varies widely, but stronger sponsors have seen rates fall to the very low teens. Burke suspects that the long-running erosion of mezz yields is near its cyclical trough, meaning it’s probably time for sponsors to cut deals. He also stressed that lenders able to originate both senior debt and mezz slices are able to offer better packages than mezz lenders not directly linked to first mortgages.

Pricing for various secondary loan sizes and structures depends on the capital provider’s investment strategies and risk profiles, along with the yields the fund manager pledged to underlying equity investors, added Weiss.

The fund manager “won’t make any money until he hits those minimum yield thresholds, so he’s not going to invest into a project at a yield that won’t be profitable” for the fund.

Finding the right deal

Weiss’ advice for sponsors seeking a good mezz deal: Match the risk-based yield criteria to lenders with a compatible appetite, and base return projections on well-documented assumptions.

Though mezz lenders typically pursue relatively short-term exit strategies, some players are now providing funds on a more permanent basis. For example, the LEM Mezzanine program, a $200 million fund sponsored by Lubert-Adler Real Estate Funds, is willing to provide mezzanine debt and preferred equity taking overall leverage up to 90% for terms up to 10 years.

Meanwhile, a new $200 million program managed by Somerset Partners is looking to fund $10 million-plus mezz loans, for multifamily properties specifically, that would mature concurrently with corresponding senior mortgages.

Even major multifamily real estate investment trust Archstone-Smith has jumped into the mezz lending business, specifically through development ventures. Archstone has made about $100 million in such investments over the past year, with an emphasis on projects in the trust’s favored markets, and typically where the developer has seen a site’s value rise substantially, chairman R. Scot Sellers explained.

Archstone has been getting yields in the “mid- to high-teens” with these investments, including pay rates and additional accruals that vary from deal to deal. Sellers characterized the capital cost as highly attractive to developers who’d likely have to pay much more for the additional straight equity required to secure construction financing.

“So if that seems like a high return for us, it’s actually a pretty inexpensive source of capital for the developers” relative to Archstone’s typical leveraged internal rate of return of more than 24% on equity joint-venture developments. Archstone’s mezzanine investment in most cases brings overall loan-to-cost leverage to no more than 85%, Sellers specified.

Archstone would like to do another $100 million or so of these deals in the next nine to 12 months.