Billionaire Paul Singer’s Elliott Management Corp. is backing a venture with Silverpeak Real Estate Partners that will originate mortgages to be parceled into CMBS, as well as make other types of loans such as mezzanine debt. In a December letter to investors, Elliott cited the “strength and growth in the new issue market,” and a “significant capital hole in need of filling,” as boom-era loans mature.
Mezzanine debt was frequently used in real estate leading up to the crash as landlords ramped up their use of borrowed money to help pay record prices for buildings. While a boon for borrowers at the time, excess leverage was at the root of some of the most disastrous real estate acquisitions.
David Lichtenstein’s Lightstone Group LLC bought Extended Stay Hotels, a chain of mid-priced hotels, for $8 billion at the top of the market in 2007. The purchase was fueled by $7.6 billion in debt including more than $3 billion of mezzanine loans that were wiped out when the hotel operator filed for bankruptcy in 2009.
Mega Transactions
The deal “was the poster child of the highly-leveraged mega transactions of 2007,” said Ed Shugrue, CEO of Talmage LLC, which oversees $2 billion in commercial property debt. “A lot of pain was inflicted.”
Banks tightened lending standards in the wake of the financial crisis, leading to lighter debt loads. Commercial mortgages in today’s CMBS deals are still more conservative than they were leading up the crash, according to Shugrue, though concern is mounting that underwriting standards on new bonds are slipping. Pinpointing individual buildings could give investors more oversight if a loan defaults. That’s an attractive proposition for firms that want to underwrite their own deals and handle problems when they arise.
“Investors increasingly want to control their own destiny,” according to Morgan Stanley’s Hill.
It may be difficult for funds without the lending infrastructure to break into the mezzanine market, according to Harris Trifon, a debt analyst at Deutsche Bank AG. It takes more due diligence and loans are not as easy to buy and sell as securities, he said.
The extra effort is worth it, according to Axonic’s Seay. Newly issued bonds rated BBB-, the lowest investment-grade ranking, are yielding about 6.6 percent, according to data compiled by Bloomberg. The 10-year mezzanine debt made by Axonic is paying as much as 11 percent annually, Seay said.
“Yield is the number one reason,” driving the funds, said Trifon.