Real Estate Capital: Private Equity Moves to the Forefront in the United States

By Michael Melody, Managing Director, Real Estate Investment Banking, Jones Lang LaSalle: In the wake of the credit crisis, the majority of US market participants had anticipated a deluge of distressed and high-yield opportunities. Veteran investors eagerly waited on the sidelines and new private equity funds were raised; however, to the industry's surprise, banks and servicers have remained reluctant to sell and have instead chosen to restructure and extend loans. The frustration of slim pickings for investors has been compounded by a significant compression in yields.

In the wake of the credit crisis, the majority of US market participants had anticipated a deluge of distressed and high-yield opportunities. Veteran investors eagerly waited on the sidelines and new private equity funds were raised; however, to the industry’s surprise, banks and servicers have remained reluctant to sell and have instead chosen to restructure and extend loans. The frustration of slim pickings for investors has been compounded by a significant compression in yields.

These newly formed funds have now taken to a new strategy in the United States that involves moving to the front of the line and actually making loans. For example, an owner looking for 75 percent loan-to-value financing may not get the proceeds and terms it needs from a traditional portfolio lender that might like the asset but may only be prepared to lend at a 50 percent loan-to-value leverage level. CMBS lenders may be interested, but any combination of aggregate risk, large asset size, vacancy or short-term tenant rollover may result in a less than desirable sizing or pricing.

In these situations, a debt or opportunity fund, flush with cash, may co-invest with the same traditional portfolio lender and layer on additional higher-yielding debt to meet the owner’s needs. The traditional lender would keep the lower-risk 50 percent leverage component and the fund would retain the remaining higher-risk 25 percent “bottom” portion of the loan in the form of a subordinate mortgage or mezzanine loan. For the owner of the property, this type of effective private placement becomes an attractive potential alternative to traditional bank, life company and/or CMBS debt placement.

An acceleration of this technique is likely in the United States as the lending markets recover and the new rules for securitization are solidified. In addition to providing critical financing, these new debt and opportunity funds may emerge as a meaningful originators and providers of large single asset debt capital.