Mezzanine debt is hot these days. It costs borrowers far less than equity and lenders are tempted by higher interest rates that offer them superior yields. Tighter underwriting standards on senior loans have also helped fuel demand in the mezz market.
The momentum began a few years ago and has been building. In 2001, a Prudential Real Estate Investors study chronicled the mezz market's growth from a virtual afterthought to a product that had contributed up to $135 billion. Prudential predicted further mezz originations of between $13 billion and $27 billion annually.
More mezz sources are surfacing, too. Teachers Insurance Annuity Association started a mezz program in January and expects to provide $200 million of mezz this year. New players are also getting in the game: Office developer Shorenstein Co. and multifamily developer Camden Property Trust both recently launched mezz programs.
“Everybody and their aunt and uncle are becoming mezz providers,” says Richard Mandel, a former Kennedy-Wilson executive. He should know — in May he started Ramsfield Hospitality Finance, a mezz financing firm in New York.
A gap between what loan-to-values mortgage lenders will offer developers and how much equity developers need is driving the mezz mania. Primary lenders typically provide 60% loan-to-value on hotel deals these days, says Christopher Buccini, a partner with Buccini/Pollin Group Inc., a Delaware-based hotel developer, while Buccini generally provides equity of 15%.
The remaining gap is filled by mezz debt. For the borrower, that's enticing because blending the rates of the conventional mortgage and mezzanine debt yields an “all-in” rate of only 6.5%, he says.
Buccini/Pollin entered into a mezz deal with Ohio-based RockBridge Capital, which provided $4 million in mezz for Buccini's 155-room Embassy Suites in Delaware and 169-room Fairfield Inn in Maryland.
Mezz is much cheaper than adding equity partners, who demand returns of more than 20%. In Buccini's case, the mezz debt helped seal the deal for the project.
Shorenstein, which owns 22 million sq. ft. of office property, also recently purchased a mezz financing piece from CDC Mortgage — a $20 million mezz loan on 350 Madison Ave. and 1440 Broadway, two New York office buildings.
Mezz debt is considered a risky piece of the debt pie. Uncertainties over projected property values and interest rates are a concern as mezz debt comes due over the next couple of years. Since mezz lenders typically use a property's equity as collateral, they will own a property if borrowers default on or are unable to retire mezz loans.
Then again, bankrupt owners could force mezz lenders to restructure loans and reap less of a return, says Mike Straneva, a partner at Ernst & Young. But mezz lenders wager the returns are worth the risk.