It’ll cost you.
As primary lenders for new condo projects in New York get more skittish, mezzanine lenders are taking up the slack, stepping in to provide additional financing.
Developers are finding that prices can be steep. Interest rates for mezzanine loans vary, but generally rates that used to be in the low teens have risen into the high teens — depending on the specific transaction, said Ronnie Levine, managing director at commercial mortgage brokerage Meridian Capital Group.
In some cases, the rates can reach as high as 20 percent to 25 percent depending on how much leverage a mezzanine lender is providing, said Doug Hercher, managing director at investment banking firm Sonnenblick-Goldman.
The financing can be a necessary evil, since mezzanine loans provide funds to help make up the difference between what a first mortgage lender will approve and how much equity the developer has to sink into a project.
“To the degree they can, most developers would like to put in as little equity as possible,” said Gregg Winter, manager of W Financial Mortgage Fund I, LLC and chief executive of Winter & Co. Commercial Real Estate Finance.
It’s not unusual for the primary or first construction lender to lend 80 percent of the total cost of a project, with a mezzanine lender handling 10 percent and the developer contributing 10 percent, he said.
But these days, primary lenders are getting more conservative. The rising interest rate environment coupled with the slowing sales market has lenders worried that it will take longer than expected to sell out a development, or concerned whether all of the units will sell in the projected price range.
Higher energy, building materials and labor costs have also heightened concerns that projects will run into construction overruns.
Finally, it’s taking longer for the state attorney general’s office to approve offering plans, said Levine. “There are so many packages in the approval process,” he said. “We’ve seen up to a year.”
These worries have caused many primary lenders to cut their contribution to around 70 percent of a project’s total cost, which means developers who want to, or need to, hold onto more cash from the mezzanine market. Mezzanine loan requests are up about 20 percent over the same period last year, Levine said.
Hercher agrees. “What you’re seeing is first mortgage lenders are being more conservative about their loans and mezzanine lenders are stepping in to fill that gap.”
It’s created big business for many mezzanine lenders.
“It’s exceptionally busy,” Winter said. “I am looking at 15 to 20 opportunities a week from all around the country.”
Still, like primary lenders, mezzanine lenders are also taking on risk and must carefully scrutinize project plans. If a developer isn’t able to fulfill his end of the deal, the first mortgage lender has a lien on the actual property, while the mezzanine lender instead will take a pledge of a partnership or ownership interest, which allows it to become the borrower and take on the resolution of the project.
Primary and mezzanine lenders must negotiate terms, and if the parties don’t devise a mutually satisfactory agreement, the mezzanine lender may walk away from a potential deal.
All lenders, including mezzanine lenders, are becoming more vigilant about working with experienced developers. “Two years ago it was much easier to get projects financed. Now lenders are more focused,” Winter said.
“In our case, our fund focuses on very strong developers with strong net worth and liquidity, and developers who have done this successfully time and time again,” he added. “We can’t predict what the market will do, but we want to make sure that the one thing that won’t happen is that the building won’t get built.”
Hercher notes that “everybody is exercising more underwriting due diligence than 12 months ago.”
He cites “inexperienced developers — and there are many in the market — as the biggest factor. “The amount of money people have made has drawn people into the business.”
In overheated markets like Miami, working with an experienced developer is even more important.
Levine’s Meridian recently closed a $14 million mezzanine loan on a 576-unit condominium development in Miami, even as many lenders have become concerned about lending in that market.
“We were able to get the [mezzanine] loan placed because of strong pre-sales and highly experienced sponsorship,” Levine said.
In March, W Financial Fund closed a $4.3 million mezzanine loan for a 12-unit, mixed-use property in Tribeca. The deal was attractive, in part, because the developer is a joint venture of two experienced New York builders, whose names W Financial declined to provide. Since it’s new construction, the building will also benefit from tax abatements.
Mezzanine loan rates tend to move in lockstep with first mortgage rates — and mezzanine lenders are following primary lenders down the trail of being more picky about fringe neighborhoods or developing areas. Although he says he considers Harlem a great market, Winter says he turned down a project on what he considered the worst block in the immediate neighborhood.
“I am not that anxious to finance a project in Long Island City,” Winter said. “I’d be more interested in Cobble Hill or Williamsburg.”