Mezzanine Financing Market Gets Crowded

The commercial real estate mezzanine financing niche may be getting crowded with opportunistic investors and it is likely that some players will be forced out of the field when times get tougher, according to some lenders at a recent Realshare structured finance conference here.

At a "mezzanine market update" panel session, lenders said that the terms that come to mind about the current mezzanine market include "frenetic," "mature," "disciplined" and "mixed bag."

To Arthur Fefferman, president, AFC Realty Capital, the word "frenetic" is what best describes the current supply of mezzanine capital for real estate financing, with real estate becoming a dominant performer and competing with the lackluster performance of the debt and equity markets.

Peter Ginsberg, managing director, Capital Trust, said that in one sign of the growth of the real estate mezzanine market, which has now "matured," no one even knew what it was seven or eight years ago and now no deal even gets done without it.

Scott Schaeffer, president and COO, RAIT Investment Trust, sees more "discipline" as the market gets more and more competitive, with debt service coverage ratios getting pushed to new levels.

Dennis Walsh, senior director, Tremont Realty Capital, sees a "mixed bag," with a lot of funding choices out there and a lot of people who are doing different things marketing themselves as mezzanine lenders.

Richard Kelley, director, Realshare conference series, who moderated the session, wondered if there are too many players in the market.

Mr. Walsh bel-ieves that spreads will tighten and there will be fewer players a year from now.

Mr. Fefferman said that the challenge is not just how to put the money out but about whether it is going to be a profitable investment. Real estate investment trusts are having a tough time finding yields, according to him, and money is flowing in from REITs.

Mr. Ginsberg believes that mezzanine funding provides an "alternative opportunistic investment" right now. When rates and spreads rise and people can't justify the investments anymore, the "dabblers" will drop out while those who have been in the field for the last few years will continue on.

Mr. Schaeffer noted that it is important to focus on an exit strategy, and to look for a "value-added element," since "we're the ones left holding the bag if rates spike."

Commenting on the "sky high" prices in the current environment, Mr. Fefferman believes there is a need to be disciplined and understand that fundamentals today are driven by interest rates rather than by market fundamentals.

One "great opportunity" he sees in today's market is in the story deals, those "with hair on them," which niche he sees as "less crowded" and rewarding for those lenders that have the skills.

He also sees an opportunity in bankruptcy situations. Mr. Ginsberg is seeing some speculation in the Southern Florida condominium conversion market.

And as commercial mortgage deals get sliced into more and more pieces, everyone is "holding our breath for the day when one of these goes down and everyone wants the right to workout," and the servicer doesn't know what to do.

He is a bit concerned about how much money is out there waiting to get into mezzanine real estate financing but believes that with the "right protections" there is a lot of opportunity in this world.

For instance, he noted, commercial mortgage-backed securities financing now accounts for about 30% to 40% of all real estate financing, up from about 2% of the total even about 10 years ago, and it is still growing, which provides opportunity for mezzanine financing.

Looking ahead to the next year, Mr. Ginsberg is waiting on an "unexpected event" that will give pause for the market, something like the Asian debt crisis of 1998, to occur. Mr. Schaeffer also expects fewer players in the market and is expecting "some sort of hiccup."

Mr. Fefferman is seeing a red flag and "a little bit of blood on the street" in the next year. He expects that the cost of capital will rise and refinancing will pose a challenge for first mortgage and mezzanine pieces. He expects there will be a "gap in the capital structure."

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