Pros Say Hedge Funds May Step Up Role in CMBS, Refinancing

As a second summer of discontent for the capital markets draws to a close, finance experts are eyeing a new category of player that is helping fill the void. “The hedge funds are here to stay for the foreseeable future until the capital markets fix themselves,” declared Cliff Mendelson (pictured), a senior managing director for Transwestern’s structured finance group. Strictly speaking, of course, hedge funds are hardly newcomers to commercial real estate; the real novelty is their higher profile. It is no secret that hedge funds have taken a stepped-up role in providing mezzanine debt, preferred equity, and other products to bridge the gap between senior debt and sponsor equity. For example, Centro’s CEO Glenn Rufrano recently noted to Australian news sources that his firm has been talking with such funds.Fund managers are perpetually searching for the highest possible return at the lowest risk. The potential for 12 percent to 15 percent returns that has emerged in the past year accounts for that appeal, Mendelson explained. Mendelson reported that the funds have provided a total of $100 million for three major transactions totaling $500 million in value that he has arranged in the past five months. “Without hedge funds,” he asserted, “real estate acquisition today would come to a complete, grinding halt.” An intriguing issue to watch in the months to come will be the role of hedge funds in refinancing loans originated several years ago before the credit squeeze, noted Fred Leffel, senior vice president for Savills. “That wave of transactions hasn’t really hit yet,” Leffel said. Nevertheless, he added, “It’s coming and we’ll see more of it.” Even owners of stabilized, well-tenanted properties could find themselves in a tight spot. A borrower today might be able to find senior financing for only 60 percent of an asset’s value, compared to 70 percent a few years ago. And if that asset’s value has also slipped, the gap for the borrower to fill is that much bigger, Leffel explained. Enter hedge funds, which could step up their activity–albeit at a premium rate. Another potential target for hedge funds is the CMBS market. Given the vast backlog of paper that originators want to securitize and sell, it is doubtful that hedge funds alone can buy enough paper to restart the market. Still, the prospect for double-digit returns on investment-grade tranches could prove appealing to hedge funds. CMBS paper could also have the advantage of being relatively low maintenance compared to other investments. “Once you buy that paper, you don’t have to do very much, as opposed to when you make a mezzanine loan,” he pointed out. “The staffing is a lot less.”