The New-New Thing: Debt Funds Are All the Rage

In a low interest rate environment, what’s an institutional investor to do? The answer, at least to us, is patently obvious: after you have exhausted all of the existing strategies, you need to search for new ones. 

Only a few weeks ago, the “new-new” thing in real estate related investments strategies was super-senior, super highly rated, tranches of commercial mortgage-backed securities which provided premium yields over U.S. Treasury securities. That is now passé as debt funds seem to have captured many investors’ attention. 

Debt funds come in numerous flavors ranging from domestic to global, from conventional to opportunistic (distressed). During the first three quarters of 2012, 14 privately placed debt funds seeking to raise $11.4 billion came to market. Sponsors of debt funds include a wide array of well-known names including: the Blackstone Group; Fortress Investment; AXA; Henderson; H/2 Capital; Mesa West; and AEW, to name just a few. 

Projected rates of return vary significantly, mirroring the type of investment the fund is targeting. A number of funds are seeking to make conventional real estate mortgage loans and effectively compete with lenders such as insurance companies, commercial banks, and securitized lenders. These funds argue that they represent a low risk investment which, compared to alternative debt investments, will provide investors with reliable distributions of cash flow. Their underwriting standards, including loan-to-value ratio, debt yield, etc. appear comparable to those of traditional real estate mortgage lenders. 

At the other end of the spectrum are the opportunistic funds which expect to target distressed borrowers and distressed mortgages, thereby providing rates of return in excess of 15 percent on an internal rate of return basis. 

There is a clear market driven need for additional sources of conventional mortgage loans and we expect these funds to raise significant amounts of capital.  

For the opportunistic funds, raising capital should not be an issue as there are plenty of institutional investors “chasing yield”; finding investments may be more challenging as many lenders have achieved significant recoveries from distressed loans on their books through their own efforts and may not see any value in selling paper to third parties. 

A Very Quiet Week

It was a very quiet (and short) week with few, if any, deals coming to market. Rates and terms quoted by lenders appeared unchanged with the market’s focus on getting transactions papered and closed by year-end. 

Monday’s Numbers  

According to its most recent Trepp survey, spreads were unchanged.

Asking Spreads over U.S. Treasury Bonds in Basis Points
(10-year Commercial and Multifamily Mortgage Loans with 50% to 59% Loan-to-Value Ratios)

12/31/09

12/31/10

12/31/11

11/23

Week Earlier

Month Earlier

Office

342

214

210

220

220

225

Retail

326

207

207

210

207

204

Multifamily

318

188

202

198

200

204

Industrial

333

201

205

209

206

218

Average Spread

330

203

205

209

208

213

10-Year Treasury

3.83%

3.29%

1.88%

1.70%

1.69%

1.62%

The Cushman & Wakefield Equity, Debt, and Structured Finance Commercial Mortgage Spread monthly survey of commercial mortgage spreads showed spreads for 10-year, fixed rate mortgages, coming in approximately 15 basis points across all property sectors over the past 30 days.

Property Type

Mid-Point of Fixed Rate Commercial Mortgage
Spreads For 5 Year Commercial Real Estate Mortgages

12/31/10

7/26/12

9/3/12

9/27/12

11/6/12

Multifamily – Non-Agency

+270

+245

+240

+235

+220

Multifamily – Agency

+280

+225

+225

+210

+210

Regional Mall

+280

+295

+290

+285

+270

Grocery Anchored

+280

+290

+285

+280

+265

Strip and Power Centers

 

+315

+310

+305

+295

Multi-Tenant Industrial

+270

+300

+295

+290

+270

CBD Office

+280

+295

+285

+280

+250

Suburban Office

+300

+315

+305

+300

+270

Full-Service Hotel

+320

+360

+360

+355

+340

Limited-Service Hotel

+400

+370

+370

+365

+350

5-Year Treasury

2.60%

0.57%

0.68%

0.64%

0.71%

Source: Cushman & Wakefield Equity, Debt, and Structured Finance.

Property Type   

Mid-Point of Fixed Rate Commercial Mortgage
Spreads For 10 Year Commercial Real Estate Mortgages

12/31/10

7/26/12

9/3/12

9/27/12

11/6/12

Multifamily – Non-Agency

+190

+220

+210

+205

+190

Multifamily – Agency

+200

+210

+210

+195

+180

Regional Mall

+175

+235

+230

+225

+210

Grocery Anchor

+190

+230

+225

+220

+205

Strip and Power Centers

 

+250

+245

+240

+225

Multi-Tenant Industrial

+190

+255

+250

+245

+225

CBD Office

+180

+245

+235

+230

+200

Suburban Office

+190

+265

+260

+255

+225

Full-Service Hotel

+290

+290

+290

+285

+270

Limited-Service Hotel

+330

+310

+310

+305

+390

10-Year Treasury

3.47%

1.42%

1.64%

1.64%

1.71%

Source: Cushman & Wakefield Equity, Debt, and Structured Finance.

Property Type

Mid-Point of Floating-Rate Commercial Mortgage
Spreads For 3 – 5 Commercial Real Estate Year Mortgages

12/31/10

7/26/12

9/3/12

9/27/12

11/6/12

Multifamily – Non-Agency

+250-300

+200-260

+200-260

+200-260

+180-250

Multifamily- Agency

+300

+220-265

+220-265

+220-265

+200-260

Regional Mall

+275-300

+210-275

+210-275

+210-275

+210-275

Grocery Anchored

+275-300

+210-275

+210-275

+210-275

+210-275

Strip and Power Centers

 

+225-300

+225-300

+225-300

+225-300

Multi-Tenant Industrial

+250-350

+230-305

+230-305

+230-305

+230-305

CBD Office

+225-300

+225-300

+225-300

+225-300

+180-250

Suburban Office

+250-350

+250-325

+250-325

+250-325

+250-325

Full-Service Hotel

+300-450

+275-400

+275-400

+275-400

+275-400

Limited-Service Hotel

+450-600

+325-450

+325-450

+325-450

+325-450

1-Month LIBOR

0.26%

0.24%

0.24%

0.24%

0.21%

3-Month LIBOR

0.30%

0.46%

0.43%

0.43%

0.31%

* A dash (-) indicates a range.

Source: Cushman & Wakefield Equity, Debt, and Structured Finance.

Year-to-Date Public Equity Capital Markets

DJIA (1): +6.48%
S&P 500 (2): +12.05%
NASDAQ (3): +13.88%
Russell 2000 (4):+9.89%
Morgan Stanley U.S. REIT (5):+7.10%

 (1) Dow Jones Industrial Average. (2) Standard & Poor’s 500 Stock Index. (3) NASD Composite Index.
(4) Small Capitalization segment of U.S. equity universe. (5) Morgan Stanley REIT Index.

U.S. Treasury Yields

12/31/10

12/31/11

11/24/12

3-Month

0.12%

0.01%

0.09%

6-Month

0.18%

0.06%

0.14%

2 Year

0.59%

0.24%

0.24%

5 Year

2.01%

0.83%

0.69%

7 Year

 

 

1.17%

10 Year

3.29%

1.88%

1.69%

                                                  

Key Rates (in Percentages)

 

Current

1 Yr. Prior

Federal Funds Rate

0.17

0.08

Federal Reserve Target Rate

0.25

0.25

Prime Rate

3.25

3.25

US Unemployment Rate

7.90

8.90

1-Month Libor

0.21

0.26

3-Month Libor

0.31

0.51