Debt / Leverage

Debt Funds: Australia Mulls Debt Funds
Sharon Hayes – IPE Real Estate Magazine
September/October 2015

There are several signs pointing to the emergence of a new commercial real estate debt fund sector in Australi. This article looks at the history of debt funds in Australia and the future of real estate debt funds.

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Lessons Learnt From Australia: The Return Of Financial Engineering – Don’t Repeat The Sins Of The Last Cycle
Anrev
August 2015

The past 6-9 months has seen a significant change in Australia’s real estate debt markets and, once again, financial engineering on paper looks a tantalising proposition to enhance returns. The purpose of this paper is to highlight the impact of various gearing scenarios on our Australian market forecasts, highlight external risks to the investment environment which could influence the sustainability of gearing, and review recent academic research on the subject. The aim is to provide guidance to the best “risk adjusted” strategy for leverage this cycle and the implications for portfolio construction in Australia.

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Real Estate Investment And Leverage: In Good Times And In Bad
Andrey Pavlov, Eva Steiner And Susan Wachter, Working Paper 764
Samuel Zell And Robert Lurie Real Estate Center
April 2014

The recent real estate bubble was arguably facilitated by the ready availability of low-cost debt underwritten at ever-increasing loan-to-value ratios. It has been asserted that sustained growth in leverage reflects myopia and irrational optimism amongst financial managers. This paper argues, however, that this rationale fails to take into account the incentives to managerial borrowing decisions induced by the fact that real estate debt can be collateralised against specific assets, rather than the firm overall. The authors derive a set of empirically testable hypotheses surrounding a rational strategy for pessimistic managers to increase non-recourse, asset-backed leverage in anticipation of a significant downward correction in underlying asset values. This strategy allows managers to reduce equity exposure to market declines in some sectors or regions, while protecting the remainder of the firm’s asset base. They find empirical evidence consistent with this hypothesis in a sample of listed US real estate investment firms. Consistent with their rationale, they also find that pessimistic borrowing is insensitive to the cost of debt, uses shorter maturities, and is inversely related to future investment, suggesting that pessimistic borrowing is indeed focused on recovering equity.

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Mezzanine Debt And Preferred Equity In Real Estate
Andrew Berman
April 2013

This chapter is from a book titled Alternate Investments: Instruments, Performance, Benchmarks, and Strategies and discusses mezzanine loans and preferred equity investments, which are two types of non-traditional real estate financing providing capital and liquidity to real estate owners. Unlike traditional mortgage loans, these non-traditional methods of financing have complex structures and different risks and benefits. Mezzanine loans are debt transactions in which the lender’s collateral is in the form of the mezzanine borrower’s ownership interests in other entities that own income-producing property. Preferred equity transactions are structured as equity investments in an entity that owns real property. These equity investments are structured as capital contributions to the entity and, in return, the investor receives a preferred return on its investment. The investor’s preferred return is the economic equivalent to interest on a mezzanine loan. Although each of these financing vehicles is structured differently (one as debt and the other as equity), both allow property owners to obtain funds in excess of the typical senior mortgage loan, increase the property owner’s leverage, and provide liquidity. This chapter discusses the unique structure of these financings and examines both the opportunities and risks for real estate owners, mezzanine lenders, and preferred equity investors.

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What’s In A Name: Mezzanine Debt Versus Preferred Equity
Dean Heller
May 2012

Mezzanine loans and preferred equity interests are both forms of investment in commercial properties; they are favored by investors, particularly institutional investors, that want a fixed, or at least floored, return and priority as to both their return on and return of investment. In its most common form, a mezzanine loan is secured by the investment property, but only indirectly, by a pledge of the equity in the entity (usually a limited liability company or limited partnership) that owns the property. Preferred equity, on the other hand, usually takes the form of a direct equity investment in the property owner, with a fixed, preferential return that is paid prior to distributions to the “common” equity interests in the owner. Apart from this difference, mezzanine debt and preferred equity can — and often do — have similar terms and conditions; nonetheless, institutional and other real estate investors appear generally to regard mezzanine debt as an intrinsically better form of investment than preferred equity. The article postulates that capital markets may be giving undue deference to the notion that one is “debt” and the other is “equity” and analyses each of the presumed legal advantages of mezzanine loans over preferred equity interests. While acknowledging that for certain type of investors and certain types of properties, mezzanine debt may be the preferable form of investment, the article concludes that, overall, preferred equity provides an investment structure that works as well as — and in some cases better than — mezzanine debt.

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