“Everybody is desperate for yield,” Richard Flohr, managing director with Prudential Mortgage Capital Company, noted on more than one occasion at yesterday’s Real Estate Capital Forum 2015 in New York City.
Delegates were left to decide for themselves if, as the old saying goes, desperate times have called for desperate measures. But it was clear based on panelist remarks that competition is stretching traditional commercial lenders into riskier assets, markets and loan types as they seek higher returns.
Much of the pressure to move into new, often higher risk areas comes from the growth of private lenders, from the mortgage REITs and private debt funds, to a range of other private equity lenders who have recently turned to debt, to a consistent wave of foreign lenders.
“Much of the capital is coming from that alternative bucket and they want a much higher yield, and we are also catering to the demand out there by moving into that high yield space,” Flohr said.
Niraj Shah, managing director with Rockwood Capital, added: “We’ve seen a lot of transient money come into the space from a lot of private equity funds raising debt funds… and we’ve seen pricing come in in a big way.”
Shah spoke of a $110m loan his firm placed on a property in Mountain View, California, a loan with “initial guidance” that stretched up to 650 bps over but ultimately priced in the low 400s.
“We really have to pick our spots to get yields,” he said, pointing to another recent example — a hotel deal his firm did in New York City. “Given the fear in the market and the supply issues, we were able to get into the high teens, so we found good value there.”
The competition has pushed traditional CRE lenders into asset types they might not have previously dealt with, into secondary and tertiary markets, and into Europe. They are originating riskier portions of the capital stack and writing more construction and development loans.
Both domestic and foreign — the latter in part motivated by tax incentives — once happy to lend senior loans on stabilized assets are dipping into the mezzanine lending and preferred equity space. Traditionally conservative state pension funds are even becoming a consistent capital source for debt.
“The riskier construction side is where we have to do a lot of our work as of late,” said Brian Sedrish, a managing director with Related Fund Management, “and we have to be willing to take that risk to get deals done.”
The firm is also making significant preferred equity and mezzanine investments in search of better yields, is pushing into Europe, where the market is “much more fragmented with a lot more opportunities,” and is more likely to consider deals with less established sponsors.
That said, “for every deal we turn down there are five people who are willing to do that deal,” he noted. “It’s becoming increasingly harder to find opportunities that make sense.”
“There’s just an abundance of competition coming into the space,” Sedrish added. “It’s a series of funds that were able to raise capital under the view that they were going to take advantage of the large spreads that they could achieve relative to benchmark treasuries or etcetera.
“And that will continue I think for a while until ultimately there’s some distress along the way and some of those groups that shouldn’t have raised that capital in the high yield space — because they might not have been equipped — will go away.”