“When a butcher starts talking about day trading, maybe it’s a sign you should disengage”

A Q&A with Terra Capital's Bruce Batkin on the mezz market

New York /
Aug.August 16, 2013 03:30 PM

With $1.7 trillion in U.S. real estate loans slated to mature in the next five years, the stage is set for a surge of new loan activity from lenders nationwide. Bruce Batkin, the co-founder of Terra Capital Partners, a New York-based real estate capital management firm, told The Real Deal that the flood of maturities will create new opportunities for alternative lenders.

Terra focuses primarily on originating, acquiring and managing bridge loans, mezzanine loans and preferred equity investments backed by commercial properties, especially since traditional lenders are still hesitant to invest in secondary and tertiary markets.

Read on for Batkin’s thoughts on the market for mezzanine financing, the drawbacks of the New York market and why he sold his company’s entire portfolio, comprised of nearly 100 mezzanine loans, in 2007.

Tell us exactly what Terra Capital Partners does.

We focus on one particular niche, which is subordinate financing. It’s what we call gap financing. We come in and fill the gap that commercial banks and [commercial mortgage backed securities] lenders and insurance companies have left, particularly in the wake of the financial crisis. We’ll do mezzanine financing, B-note financing and preferred-equity financing, which we structure as debt. On the senior portion, we’ll do bridge financing for a property [as it transitions] from one condition to the next.

You stopped lending for a while after the financial crisis. What was the market for financing like before the crash?

We were seeing financing of as much as 90 percent from certain senior lenders on very high quality stabilized assets and similarly we were lending in the mezzanine space up to 90 percent. We were going behind a 75 or 80 percent first mortgage up to 90 [percent] and sometimes a little bit more.

What is the market like today?

I don’t think there’s necessarily a hard and fast rule. It depends on the asset class. Retail, unless it’s super high quality, isn’t going to attract 80 percent financing, but we’re seeing lenders go certainly to 80 percent at least for multi-family.

What prompted you to sell Terra’s entire portfolio in 2007?

Basically, luck met planning in 2007. We felt uncomfortable beginning in late 2006 – it was pretty obvious things were getting overheated — and decided to sell off, little by little, bits of our portfolio. The biggest red flag was that people who had no experience in our niche, meaning the mezzanine niche, were getting into the business and hedge funds were looking to do CDOs [collateralized debt obligations, a type of structured asset-backed security]. Just because you’ve done corporate financing doesn’t mean you understand the dynamics of real estate financing. When a butcher starts talking about day trading, maybe it’s a sign you should disengage.

How come you ended up selling the whole thing at once?

We had one buyer for the whole thing, a group out of Australia. They turbocharged the portfolio by levering it up. We had some ambivalence once we saw the returns they were able to achieve immediately after we sold but they ended up going into receivership about 18 months after the sale.

Where did that leave you once you started investing again?

It has really helped us, not only in terms of fundraising at this point in the cycle, because there’s credibility there, but more importantly that we don’t have the pre-crisis legacy assets and so that’s not a drag on management time. We can focus exclusively on fresh deals.

Are banks back to lending at the same level as they were pre-crash?

The banks are a lot healthier than they were in 2009 and 2010. That’s giving them latitude to begin to recognize certain problems on their books. We’re finding that banks are increasingly willing to accept write downs. Certainly, a portion of our business is providing refinancing proceeds to borrowers who are refinancing loans at a discount.

You’re a New York-based company but you haven’t been active here recently. Why is that?

We’re not really deploying capital here because we’re not as competitive as we need to be. We see better risk-adjusted returns for our capital – fixed-income investment – outside in secondary and tertiary markets. If you want to put out big dollars in the mezz tranche, you need to look at big buildings and big transactions, so that’s large national portfolios or large single assets in major markets like Manhattan. We’re not in the large balance space for a number of reasons. We like better diversification. We also see better returns on smaller loans outside of New York.

Would you consider Brooklyn?

We’ve been open to the idea of Brooklyn for a long time. We financed a big conversion in Downtown Brooklyn, a $17 million loan on Beltel Lofts [a condominium project] with Credit Suisse. They did the senior piece and we did the junior piece.

What is the future of the mezzanine financing market going forward?

Close to $2 trillion worth of securities will be maturing from 2013 to 2017. There are a lot of refinancing opportunities, which is good for not only senior lenders getting back into the market but also for subordinate lenders. More capital is running into the market and so spreads will get compressed, meaning it’s also a good time to be a borrower.

How active is Terra right now?

We’re trying to close a deal a week at least. We’re what I call a high-octane lender. We’re looking to lend to high-quality borrowers on high-quality properties producing sustainable cash flow or properties that are transitioning to sustainable cash flow. We think of ourselves as an alternative to equity.

What are the challenges of the market?

We have a lot of deals that come in and it’s really about finding the ones that work. It’s not shooting fish in a barrel.

Who are your biggest competitors?

It’s not overpopulated space. There aren’t that many in the smaller balance space because it’s not the most efficient space. If you’re underwriting a $50 million loan, you go through the same process as if you’re underwriting a $5 million loan. We try the best we can to commoditize what is a bespoke process and have our documentation as uniform as we can to process these as efficiently as possible.

What are you willing to compromise on when competing for a deal?

I would compromise on the term of the loan. A lot of lenders won’t do 10-year money, but I will, even though I prefer to do three to seven years. We don’t really have rules.


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