Private equity firms have been moving into debt financing at all different levels of the capital stack with increased velocity over the past 24 months.
“The number of players has widened and where they are focusing their energies also has widened out,” says Neil Bane, senior vice president, capital markets, at Walker & Dunlop, a provider of commercial real estate financing solutions, in New York City. Originally, that shift started a few years ago with big players such as Cerberus, Blackstone and Colony Capital stepping in to provide debt financing to investors buying pools of single-family home rentals. That segment of the market has evolved to the point where private equity firms are now providing capital to a variety of property types as well as the acquisition of land for new development.
Blackstone recently loaned $102 million for the development of Hyde Resort & Residences in Miami. The $200 million condo and hotel project includes more than 400 units. In another Miami deal, Canyon Capital Realty Advisors LLC provided a $157 million senior construction loan to a joint venture between the Related Group of Florida and SBE Hotel Group to finance the development of the SLS Brickell Hotel & Residences.
Private equity firms are focusing primarily on making mezzanine and bridge loans, as well as construction loans. To a lesser extent, they will also do long-term permanent loans. “The investment horizon of a private equity firm is shorter, which necessitates the life span of their loans having a shorter maturity date,” says Jay Sakalo, a partner in the business finance restructuring practice group at the Miami-based law Firm Bilzin Sumberg.
Private equity groups have had tremendous success in raising large amounts of capital. Blackstone alone has raised billions of dollars. That has allowed these firms to take a much broader approach to real estate investment in not just buying properties, but also providing mid- to high-yield debt financing to the market, says Bane. “And I think we are going to continue to see that for the foreseeable future,” he adds.
Debt financing, particularly as it relates to mezzanine and bridge loans, also offers higher yields. Mezzanine financing might generate returns in the low teens compared to cap rates for trophy assets in major metros that have dipped below 6 and even 5 percent in many cases.
Private equity firms are filling a void in areas where other lenders have not been as active, such as properties in transition or borrowers that have less than stellar credit. For example, pre-recession there were a number of Wall Street firms and conduits providing construction financing and bridge loans. That is not a case today and private equity players see that as an opportunity. They have also been active in providing financing for condo conversions that are making a comeback in markets such as Florida.
“What you find today is that the larger banks, Wells Fargo and Bank of America, are reserving their balance sheet for their best clients,” says Bane. “So, private equity firms are taking advantage of that and trying to provide service to a broader audience and higher leverage financing for properties in transition.”
So how do private equity loans stack up to other financing sources for borrowers? Private equity money is by no means cheap. Rates for private equity loans are typically higher than for other institutional lenders such as banks, life companies and CMBS money. That being said, rates can vary widely depending on the individual deal and its structure, says Sakalo.
Where private equity lenders often gain a competitive edge is speed and less bureaucracy in their decision making, notes Sakalo. For example, Sakalo has worked on bridge loan deals that have closed in less than 30 days. In addition, private equity firms generally don’t require developers to give personal guarantees. Another advantage is that they can co-invest, bringing capital to both the debt and equity side of a deal.
Yet there is no guarantee on how long private equity will remain committed to providing debt financing to real estate. Private equity has traditionally done a very good job of asset allocation and understanding where their money should be deployed based on perceived opportunities on a short-, medium- and long-term basis, says Sakalo. “So depending on where real estate goes overall in the economy will dictate how long of a play this remains for private equity,” he notes.