April 26, 2017

Andy Little

Like Sammy Hagar trying to replace David Lee Roth as Van Halen’s lead vocalist in 1985, debt funds are seeking to fill the void left as bank lenders have dialed back their leverage levels.

What exactly are debt funds? They are non-bank lenders formed with contributed equity from institutional investors. The debt funds then leverage the contributed equity to create a pool of capital that essentially is outside typical bank regulators’ purview.

Debt funds’ ability to raise capital comes at a time when most institutional capital believes the real estate cycle is getting top-heavy and vulnerable to a correction.

 The argument for debt vs. equity is that debt caps out at 80 percent or 85 percent of the capital stack and offers a 15 percent to 20 percent buffer against capital losses in a downturn.

So the combination of plenty of interested investors with lower debt levels being offered by traditional banks has allowed these types of lenders to proliferate. According to Commercial Mortgage Alert, some 68 debt funds have raised capital recently to catch this trend.

Commercial morgage-backed security, or CMBS, lenders, which spent years living off a reputation for higher-leverage lending and not worrying much about their image in other categories, now find it difficult to compete with the mantra that 70 percent leverage is the new 75 percent.

To compound the problem of not competing at higher leverage points, pricing at the end of 2016 and the first few months of 2017 also was not attractive. Interestingly, CMBS lenders are making a sort of rebound as the latest deals to price are more competitive.

According to the John B. Levy National Mortgage Survey, rates currently are in the 3.5 percent to 4 percent range for five- and 10-year mortgages from life insurance companies.

Fuller-leverage loans from Fannie Mae and Freddie Mac are pricing 0.5 percent higher, and five-year bank loans are pricing in the 4.25 percent to 4.5 percent range. Conduit lenders, meanwhile, now are competing in the 4.5 percent to 4.75 percent range for fuller-leverage 10-year deals.

Another area where conduit/CMBS lenders have been maligned is with their ability to service everyday requests from borrowers post-closing.

Any borrower who has had a request of their conduit lender has a story of woe. While there have been a number of efforts to change this problem, there has been no real need to do so, as long as CMBS provided a competitive advantage elsewhere.

For newly originated loans, there are signs that borrowers will get some relief.

According to Commercial Mortgage Alert, Wells Fargo has eliminated clauses from their loan documents that allow servicers to charge for minor reviews, and they have streamlined approvals so that borrowers can get more timely responses. This is a positive trend that is long past due and may help to attract borrowers back to CMBS loans.

More competitive pricing and terms are coming just in time for CMBS lenders to capture the approximate $54.4 billion in CMBS loans that will mature between now and August, according to Trepp LLC, a New York-based provider of analytics and commercial real estate information.

Included in that total are two enormous loans from the 2007 CMBS offering dubbed JPMCC 2007-LDPX. The two loans are secured by portfolios in Northern Virginia, and according to Trepp, the defaulted loans will contribute to losses on the overall offering that could reach into the AAA classes.

According to Trepp, there are 41 CMBS loans in the Richmond Metropolitan Statistical Area that mature between now and August. The total outstanding balance amounts to approximately $223.9 million.

The largest single loan balance is about $36 million, which is secured by 6603 W. Broad St., also known as the Alcoa Building. The 187,190-square-foot building is fully occupied by Philip Morris USA as its headquarters with a lease that matures in 2024, according to Trepp.

The owner is 6603 Broad LLC, which was owned indirectly by Reynolds Office Property LLC when the loan was originated in 2007. The loan matures in August and is listed as current.

Of the total loans that mature in the Richmond MSA by August, only 65 percent are listed by Trepp as being current, which means there are more than $78 million in CMBS loans that are in some form of delinquency, or real estate-owned, in the Richmond MSA.

John B. Levy & Co. investment banker Andrew Little can be reached at