Monday’s Numbers: November 26, 2012

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.

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.

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.}