Over the past few years, the story with allocators investing
in private equity had a rich-man, poor-man quality. A spate of
big distributions left cash on hand but nowhere comparable to
invest it. Real estate emerged as a go-to asset class, driving
up valuations alongside a growing public demand for properties,
which only added to an already frothy market. Now, as interest
rates are beginning to rise, investors are wary of a correction
and turning to parts of the real estate debt market as a
Commercial real estate bridge loans are one such hedge.
Bridge lending is a type of temporary financing that fills in
gaps while developers make changes to a property, like
renovations or repurposing. Historically, bridge loans have
been done one deal at a time, with developers seeking financing
based on a business plan and a 12- to 18-month timeline for
repayment. Traditional bank lenders have been in and out of
this market, since underwriting can be tricky: Buildings in
transition often have negative cash flow when they apply for
financing, which is a hard sell to banks. As a result, nonbank
lenders have stepped in to meet the demand at interest
rates slightly above the banks. Those nonbank lenders are
beginning to approach bridge lending more systematically by
raising short-term debt funds.
On January 4 Los Angelesbased Mesa West Capital closed
its fourth and largest fund to date, at $900 million. The
vehicle will originate short-term loans ranging from $20
million to $300 million. Mesa West was one of the first
managers to focus exclusively on commercial real estate debt
and has since deployed more than $11 billion of loans.
When we launched our first fund in 2005, there
werent that many institutions, beyond insurance
companies, in this space. But weve seen more
institutions, and pensions specifically, come around to the
asset class, says Mesa West co-CEO Jeff Friedman. Both
the San Joaquin County Employees Retirement Association
and the Indiana Public Retirement System disclosed commitments
to Mesa West Real Estate Income Fund IV as part of their real
estate allocation. Other investors include corporate pensions,
endowments, foundations, and sovereigns.
Friedman says the current fundraising environment is strong
for firms that have an existing track record, and he expects
that 2017 will be a solid year in terms of lending volume.
This is a demand that always exists, he
Christopher Acito, founder, CEO, and CIO of New
Yorkbased limited partner Gapstow Capital Partners,
agrees, arguing that 2017 looks like a particularly interesting
year for bridge financing. This is an industry that is
now turning to institutional investor capital as its primary
source of financing, he says. Gapstow invests in both
credit managers and assets and has committed approximately $100
million to bridge lending and other small-market commercial
real estate debt strategies.
According to Acito, in addition to the consistent demand for
new bridge loans from developers, 2017 will also see a wave of
ten-year commercial-mortgage-backed securities (CMBS) vehicles,
which were put together just before the financial crisis, hit
maturity. Many of those vehicles will need refinancing, and
traditional banks will have to contend with newly implemented
risk-retention rules, which could limit new CMBS issuance,
creating an opportunity for nonbank lenders to step in.
At the upper end of the market, leverage limits on banks are
also likely to keep the advantage with nonbank lenders.
There is a real void when it comes to moderate-leverage
large bridge loans, and weve been able to step in and do
those deals, says Boyd Fellows, managing partner at San
Franciscobased Acore Capital. Fellows adds that demand is
spread consistently across major cities and large metropolitan
areas. We are confident that this will continue over the
next one to two years, he says.
Despite this rosy picture, some managers remain
philosophical about how broad-based institutional investments
will be in the near term. David Loo and Richard Ortiz,
comanaging partners at New Yorkbased Hudson Realty
Capital, have had Gapstow as an LP since 2011. The relationship
grew from what was basically a separately managed account, a
setup that the team at Hudson has since used with other
interested LPs. According to Loo, even though investors are
coming around, theres still a lot for them to get
comfortable with. I dont think traditional core
class-A investors are all of a sudden going to start getting
into subordinated debt across the spectrum, he says.
But there is more interest in the space than there has
There are advantages for both developers and investors that
opt to go the private lending route: Borrowers are assured that
the transaction will close, and debt investors have the
security of a path to recovery even if a deal goes sideways.
The transactions are also somewhat difficult to source,
creating natural barriers to entry. There are shoe
leather costs with this type of lending, Gapstows
Acito says. You have to be local; it requires loan
origination and networking. You cant look up these deals
on a Bloomberg. But we think its worth it.