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Shopping Centers Today -> September 2001
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BORROWERS EYE MEZZANINE LOANS
Funding tool gains ground
By Donna Mitchell
Mezzanine financing is gaining acceptance as a funding tool for shopping center developers, according to industry executives.
Case in point: One of the largest shopping center financiers, New York City-based Teacher’s Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), said it may launch its own mezzanine-funding program.
“There is some room to make 12% to 18% return,” said Rick Coppola, a managing director at TIAA-CREF, and a member of its strategic initiatives group. “We’re looking at properties where we think we can lend in those ranges.”
A debt-and-equity instrument, mezzanine financing is a second commercial mortgage for which repayment is second in line to the first mortgage. Midsized retail property owners particularly have been using the tool for about eight years to cope with specific situations. It can be an alternative to issuing common stock, securing more bank loans or leveraging a property beyond the confines of a first mortgage.
A prime driver for TIAA-CREF’s interest is the way owners now leverage their properties. Historically, retail properties were financed with 75% debt and 25% equity interests, Coppola said. Thanks to changes in the commercial mortgage-backed securities (CMBS) markets, properties are indebted up to 65%, while the equity apportionment remains at 25%. That leaves room to leverage between 10% and 15% of a property’s value.
If TIAA-CREF garners enough incentive from its research, it might complete its first mezzanine loan by year-end, Coppola said, and designate $200 million for mezzanine lending. The new program would likely fall under TIAA-CREF’s existing mortgage lending program, which exceeds $3 billion.
New York City-based Allegiance Capital Partners, founded in 1999, is a mezzanine lender to commercial property companies, and has several retail property financings on tap for 2001. It launched a product in June called “Top-off-the-Tank” financing, offering long-term, fixed-rate mezzanine loans of up to $15 million, with terms of up to 10 years. Allegiance Capital Partners managed to cut out the intercreditor agreement from its loan program.
Intercreditor agreements are contracts between the borrower, the lender of the first mortgage and the mezzanine lender that protect their respective interests in the deal. The agreement is often a sticking point in mezzanine loan transactions.
“We spent a tremendous amount of time and legal fees making sure that we did not disturb the first-mortgage documents,” said Dean Britton, managing partner at Allegiance Capital.
Mezzanine debt is hard to quantify. Most deals are private transactions; therefore, information on how much mezzanine debt is currently outstanding, or how much has been issued since its inception, is widely unavailable.
According to Christopher J. Niehaus, a managing director at Morgan Stanley who heads its real estate investment banking group, the mezzanine market has become very active over the last six to nine months. He attributes this to several factors: Investors are hungrier for yield vs. growth, declining interest rates are prompting borrowers to tap into mezzanine financing and more players are entering the sector.
As long as Treasury rates remain low, and the CMBS market continues to progress, mezzanine lending will continue to be a viable capital alternative, said Rick Abrams, a managing director at First Union of Charlotte, N.C. And as new lenders continue to jump into the market, mezzanine funding will mature.
John B. Levy, president of Richmond, Va.-based John B. Levy & Co., an investment banking firm, said banks, life insurance companies, Wall Street firms and nonbank lenders have realized that they can earn respectable yields on the loans. So they are providing more mezzanine financing, thus expanding the market. Compared with first mortgages, which sometimes carry interest rates of about 7.5% based on the U.S. Treasury rate, mezzanine loans carry interest rates of at least 12% — generally based on the property’s untapped equity.
“The mezzanine loan is subordinate to the first mortgage, yet senior to the borrower’s equity position,” Levy explained.
Abrams said First Union, which actively makes mezzanine loans to retail property owners, likes the mezzanine financing business because of its excellent risk-adjusted returns. One of Abrams’ clients, privately held developer Lat Purser & Associates, Charlotte, N.C., used mezzanine financing to rehabilitate the Golden Gate Shopping Center in Greensboro, N.C., after bank lenders and equity partners refused to further leverage the property.
The $2.5 million deal was completed in April. The power center will get a new Staples, plus a more modern look, said Bob J. Otten Jr., president of Lat Purser & Associates. He said some mezzanine borrowers accept the higher interest rates because they have already exhausted traditional sources of financing.
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