Difficulty in deploying capital has led many mezzanine providers to withdraw, reports Lauren Parr
Pure mezzanine lenders to European real estate are becoming rarer and the way mezzanine debt is being put out is changing. Taking their place are funds that cover a wider risk spectrum, while at least a handful of those that jumped on the bandwagon initially have withdrawn because they could not deploy capital over a specific time period.
CBRE’s second annual mezzanine market report finds that the two main barriers to mezzanine lending are finally being tackled. First, in response to the scarcity of senior debt that has hindered mezzanine providers’ ambitions during this cycle, new strategies are emerging. And second, competition for opportunities is driving down high return expectations.
Broader debt funds are in favour, from senior to stretched senior and whole loan facilities. Take, for example, REPIA, the $3bn global property debt fund recently launched by Goldman Sachs, which will provide senior and mezzanine debt. This is more profitable than offering mezzanine loans alone, because it allows the fund to go after riskier deals with higher returns.
Meanwhile, whole loan funds such as Starwood Capital’s represent a way of lending that involves “less execution risk”, says one lender, because there is no senior bank to negotiate with (see news).
Offering short-term, one- to three-year whole loans where senior lenders do not have the risk appetite – one example being Chenavari’s £3m first mortgage deal on a retail asset in Kingston – is also a means of deploying capital.
The challenge of deploying capital has driven away 19 lenders in the past 12 months, CBRE calculates. Five of those that withdrew were family offices that could not meet their high return requirements.
Returns cut down to size
Even some of the most established mezzanine providers have been forced to drop their return targets. Average returns have dipped slightly, from 15.9% to 15.6%, according to CBRE. Internal rates of return on good-quality asset deals that have closed have been close to the low teens or high single digits.
ICG-Longbow, which is in the market with a third, follow-on mezzanine fund, advised by placement agent Threadmark, is believed to have cut its target return to 10-12%, even though its current UK Real Estate Debt Investments 2 vehicle has easily hit its 12-14% total return objective.
The mismatch between the pricing acceptable to borrowers and the returns sought by providers has clearly begun to diminish, which is allowing deals to get done; transactions in the first half of this year were up on the same period last year.
CBRE logged 18 deals totalling more than €500m, by nine lenders, in the past 12 months. But the pricing mismatch has not vanished; some deals still close without a mezzanine piece, where the price is too expensive or at par with the cost of equity.
Despite more than 15 asset managers out there fund raising for dedicated debt funds, CBRE expects the overall number of mezzanine lenders to shrink in the coming year, with more opportunistic lenders such as property companies being the next to back out as pricing continues to fall. Ultimately, the success of these funds in deploying mezzanine capital will depend on the pricing of their loans.
M&G tops mezzanine deal table with €100m German housing loans
A large slice of the €500m-plus of mezzanine deals CBRE recorded for the past year was accounted for by M&G Investment’s recent €100m, five-year loan to Vitus Immobilien’s German multi-family housing portfolio. The rest of that deal was securitised in the Florentia CMBS (see October issue).
Smaller deals in the pipeline include a £7.5m loan Chenavari is about to provide for a UK student accommodation transaction. It also lent a UK investor €15m over two years to refinance a shopping centre in Germany.
One of the latest mandates in the market is Deutsche Bank’s pursuit of £150m of mezzanine financing, on behalf of GIC Real Estate and LBREP, to refinance the maturing debt secured against their 61 Holiday Inn hotels across the UK. It is also Deutsche Bank requires £150m of mezzanine debt to help refinance Holiday Inns in the UK seeking £400m of senior debt.
LaSalle Investment Management, meanwhile, recently made its first European investment outside the UK, providing €21m for Thor Equities’ purchase of a retail block in Cannes, France. LIM is one of five asset managers that are raising follow-on funds to mezzanine debt vehicles raised in 2010/2011. M&G is another, along with ICG-Longbow, DRC Capital and Pramerica Real Estate Investors.
The latter is about to close a new vehicle targeting core junior debt in the UK and Germany. Its existing, $800m UK and German mezzanine debt fund, Pramerica Real Estate Capital 1 Fund, is likely to be fully invested by the end of the year.
Some of its deals include mezzanine loans for a shopping centre in Cologne, a retail warehouse in south-east England, London retail deals in South Kensington, as well as a mezzanine loan for Value Retail’s La Roca outlet village near Barcelona in Spain.