Investors are getting excited about mezzanine funds. The latest INREV investor intention survey found that 36% of respondents had invested in mezzanine debt compared with 17% a year earlier. CB Richard Ellis reckons that more than 100 mezzanine lenders have sprung up since the collapse of Lehman Brothers.
As banks cut their loan-to-value ratios from up to 90% or higher during 2005-2007 to 60-75%, many assumed that a lending market for bridging the lending gap would emerge. But so far, the role of mezzanine lenders has been limited – investors seem to want only risk-free, low-yielding core assets.
Investors in mezzanine funds want opportunistic returns for the risk they are taking. For mezzanine fund managers it is difficult to achieve double-digit returns when the asset yields only around 5%. A case in point was Pramerica providing £36.4m mezzanine finance for the £242.5m (€286m) purchase of Drapers Gardens by Evans Randall.
Pramerica was to charge 13.5% interest but receives only 5% interest a year, where most mezzanine funds would want an 8-10% coupon. Pramerica hopes to make up the difference upon the sale of the asset. To many, the mezzanine participation looked more like an equity investment.
Dropped from MidCity Place deal
Pramerica was sidelined in a second mezzanine-funding deal. It was to fund £50m of debt as part of the refinancing of Beacon Capital Partners’ MidCity Place in London. However, it is understood that the refinancing will now comprise a senior loan of around £154m and an equity top-up from the opportunity fund owner.
One source told Estates Gazette, EuroProperty’s sister title, that the reversion to a more traditional structure on this deal was a “blow” to the increasingly competitive mezzanine market.
But Pramerica’s chief executive officer, Allen Smith, is not worried about not being able to place the capital. “Our overall strategy is very focused on debt,” says Smith. “There is a thematic opportunity around deleveraging and this appears to have some durability. Other windows of opportunity open and close very quickly, but the debt opportunity is more sustainable. It all goes back to the financing gap as loans mature over the next few years.”
Natale Giostra, head of UK and EMEA debt advisory, real estate finance, at CBRE, also believes that mezzanine funds will play a bigger role in the future as more secondary assets come to the market.
In a recent report, Giostra pointed out that €530bn of commercial real estate debt is to mature over the next three years. About a quarter of outstanding debt has poor collateral and high LTVs. This is the area in which mezzanine finance can work, achieving opportunistic returns.
The restructuring of the Blackstone hotel fund, BRE/Hospitality Europe, in December shows that mezzanine funding works best away from the trophy assets. The deal splits the firm’s original €480m facility into a new €330m loan provided by Aareal Bank, Citibank, Deutsche Post Bank, ING Bank and Swiss RE, and a newly created €150m mezzanine facility with Morgan Stanley Real Estate Fund.
The restructuring extends the maturity of the company’s debt by five years in order to help it get through the low point in the hotel cycle.
BRE/Hospitality Europe owns nine luxury hotels comprising 3,423 bedrooms in Amsterdam, Brussels, Frankfurt, Paris, Prague and Stockholm.
