Hedge funds are zeroing in on America’s malls and hotels.
Axonic Capital LLC, LibreMax Capital LLC and Saba Capital Management LP are among firms positioning to provide loans as more than $1 trillion in commercial real-estate debt originated before the property crash comes due over the next three years, aiming to bridge the gap for borrowers needing more cash than banks are willing to lend.
“New participants are capitalizing on that void,” said Richard Hill, an analyst at Morgan Stanley, who said he’s surprised by the range of investors entering the market. “The wave of loans coming due is going to create a bottleneck. The image I get is a snake trying to swallow an elephant.”
Funds that buy corporate debt or mortgage-backed securities that package dozens of loans are targeting individual buildings, drawn by yields as high as 15 percent after returns elsewhere in credit markets shrunk. The firms are wagering commercial property values will continue to rebound after recouping 75 percent of their decline since 2009 even with the record wave of maturing loans.
About $350 billion in commercial-real estate debt comes due every year through 2017 after a borrowing binge last decade, according to Morgan Stanley. The firms are aiming to provide mezzanine loans, which are repaid after traditional commercial mortgages if a borrower defaults, making them a riskier bet in exchange for higher yields.
Axonic, a $1.8 billion investment firm run by Clayton DeGiacinto, will seek to lend on properties beyond major metropolitan areas such as New York and San Francisco, where capital from around the globe has already flooded in.
The best opportunities over the next several years will be venturing into smaller markets, even as tenant demand is harder to predict, according to Chris Seay, a managing director at Axonic’s Soma Specialty Finance, the unit started last year to make the loans.
“There’s always a demand for good quality real estate no matter where you are,” he said. “Whether it’s a Nashville, Tennessee or a Louisville, Kentucky, there’s no reason those markets don’t need good quality operators and good quality real estate.”
Axonic’s Soma is making fixed-rate loans with terms of about 10 years. It completed its first deal in November, a $5.9 million loan for shopping center Canyon Crossings in Riverside, California. The loan, which is helping to finance an acquisition, will be subordinate to a $40 million mortgage. Axonic’s main fund also buys shorter-term debt.
LibreMax, the $2.7 billion investment firm founded by former Deutsche Bank AG trader Greg Lippmann, is investing in hotel debt, according to two people with knowledge of the strategy, who asked not to be identified because the loans are private.
Lippmann, who gained fame by betting against subprime-mortgage bonds before housing collapsed, has made commercial-real estate a key part of his firm’s strategy as the markets recovered.
Hotel values, which decline fastest during an economic downturn, can rebound rapidly as room rates are reset on a daily basis. Prices on hotels surged 17 percent in 2013, according to a preliminary reading of the Moody’s/RCA Commercial Property Price Index.
The New York-based firm had more than 25 percent of its assets invested in commercial real estate at the end of December, according to a letter to investors, which showed the fund gaining 12.9 percent last year. Lippmann declined to comment on the investments.
Boaz Weinstein’s Saba, a $3.9 billion investment firm started in 2009 to trade on price discrepancies between loans, bonds and derivatives, moved into mezzanine real estate lending last year, according to people with knowledge of the fund, who also asked not to be named.
The investment ties into a broader property bet for Weinstein, the former co-head of global credit trading at Deutsche Bank. His firm was one of the first hedge funds to start digging into the riskiest corners of the $550 billion commercial mortgage bond market last year by purchasing securities that are first in line to take losses from new deals.
Investment in commercial real estate debt is increasing as sales of securities linked to properties ranging from mobile home parks to Hawaiian resorts are poised to climb to $100 billion this year after doubling to $80 billion in 2013, according to data compiled by Bloomberg.
Billionaire Paul Singer’s Elliott Management Corp. is backing a venture with Silverpeak Real Estate Partners that will originate mortgages to be parceled into CMBS, as well as make other types of loans such as mezzanine debt. In a December letter to investors, Elliott cited the “strength and growth in the new issue market,” and a “significant capital hole in need of filling,” as boom-era loans mature.
Separate from Silverpeak, Elliott is investing $75 million for a hotel and condominium project in Manhattan, according to a person with knowledge of the deal. The preferred equity will yield between 15 and 20 percent, said the person, who asked not be named because the deal is private.
Mezzanine debt was frequently used in real estate leading up to the crash as landlords ramped up their use of borrowed money to help pay record prices for buildings. While a boon for borrowers at the time, excess leverage was at the root of some of the most disastrous real estate acquisitions.
David Lichtenstein’s Lightstone Group LLC bought Extended Stay Hotels, a chain of mid-priced hotels, for $8 billion at the top of the market in 2007. The purchase was fueled by $7.6 billion in debt including more than $3 billion of mezzanine loans that were wiped out when the hotel operator filed for bankruptcy in 2009.
The deal “was the poster child of the highly-leveraged mega transactions of 2007,” said Ed Shugrue, CEO of Talmage LLC, which oversees $2 billion in commercial property debt. “A lot of pain was inflicted.”
Banks tightened lending standards in the wake of the financial crisis, leading to lighter debt loads. Commercial mortgages in today’s CMBS deals are still more conservative than they were leading up the crash, according to Shugrue, though concern is mounting that underwriting standards on new bonds are slipping. Pinpointing individual buildings could give investors more oversight if a loan defaults. That’s an attractive proposition for firms that want to underwrite their own deals and handle problems when they arise.
“Investors increasingly want to control their own destiny,” according to Morgan Stanley’s Hill.
It may be difficult for funds without the lending infrastructure to break into the mezzanine market, according to Harris Trifon, a debt analyst at Deutsche Bank AG. It takes more due diligence and loans are not as easy to buy and sell as securities, he said.
The extra effort is worth it, according to Axonic’s Seay. Newly issued bonds rated BBB-, the lowest investment-grade ranking, are yielding about 6.6 percent, according to data compiled by Bloomberg. The 10-year mezzanine debt made by Axonic is paying as much as 11 percent annually, Seay said.
“Yield is the number one reason,” driving the funds, said Trifon.