A flattening credit curve is leading to greater demand for mezzanine debt among commercial real estate borrowers. “When the credit curve is steep, each incremental dollar of debt is expensive. When it is flat-and it has flattened quite a bit-there will be even more pressure among borrowers to put leverage on, ” said a lender at an insurance company.
The last time credit curve saw substantial flattening was in 2006-2007, when BBB-rated CMBS were in the range of swaps plus 85, and AAA-rated, super-senior bonds were trading at swaps plus 60. While the differential isn’t as narrow right now-BBB bonds are at around swaps plus 272, while AAA bonds are at 52-it’s substantially flatter than when BBB-rated bonds were trading at swaps plus 800- 900 at the height of the credit crisis, market players told REFI.
CIT Real Estate Finance started to see more borrower requests for mezzanine debt at the start of the year. “It’s a function of developers wanting to put in as little equity as possible,” said Matt Galligan, president. “As the years have gone by, the spreads on mezzanine debt have diminished. Spreads are 8-12%, depending on risk, and the number of mezzanine lenders is amazing.”
Market players told REFI the capital structure has been capping out at 85%, with the bank market at 65-70% and the mezzanine market at 15%. For floating-rate loans, borrowers are seeing pricing of about 3-3.5% all in.
From a borrower’s perspective, the choice to tap the mezzanine market is easy to understand, said Andrew Kirsh, co-founder of law firm Sklar Kirsh, which works with commercial real estate borrowers and lenders. “If you can get a 65% senior loan and finance a portion of the remaining 35% with additional debt, a mezzanine loan is generally less expensive than equity,” he said, noting that mezzanine lenders also don’t share in the profits the way equity investors do. “When borrowers take on mezzanine debt, they have to act on their business plan efficiently and effectively because it’s like there’s a gun pointed to them that is fired every month,” he added.
Karlin Real Estate, which mainly targets transitional assets, has been getting more requests in recent months for mezzanine loans of three to five years where the sponsor is taking some lease-up or rehab risk, said Larry Grantham, managing director.
Rick Jones, a partner at law firm Dechert, noted a concern in today’s market is the amount of capital chasing transactions, particularly on the subordinate debt side. “It’s hard to make money anywhere across the capital stack. Margins are being compressed and people are running harder to make as much money as they made last year. Last year, we were all geniuses. This year, it’s no longer easy,” he said.