The debt markets continued to thrive in the first half of 2014, with new lenders entering the space and existing lenders looking for opportunities to distinguish themselves from the pack. This is providing an attractive lending environment for investors, driving rates downward as spreads tighten and the indices remain relatively flat year over year.
Lenders are particularly bullish on Boston, attracted to the strong fundamentals, diversified industry base, growth in the heath and medical sector and supply constraints. The relatively small number of trophy asset trades here compared to other major metropolitan areas is leading to especially tight competition on core assets in the CBD, where life insurance companies and banks continue to dominate. However, it is the non-core transactions that may be the biggest beneficiary, as lenders look to provide higher leverage and move to secondary markets in order to deploy their capital.
The biggest move in spreads over the past 12 months has been in the mezzanine debt market. In that arena, there are well over 50 players actively seeking to put out money. Whereas 12 months ago rates were in the high single-to-low double digit range, today mezzanine debt is regularly pricing in the 6 to 8 percent range in core markets like Boston.
In addition to spread, these lenders are competing on process, often taking down the entire debt stack and selling the senior position post-close. This approach is particularly attractive to borrowers, as it allows them to avoid taking on any syndication or intercreditor risk.
This whole loan approach has put significant pressure on the high-yield and finance company lenders that have historically played in the space between traditional bank/life company lenders and the high leverage debt funds. In response, these lenders have to stretch further in leverage and lower their spreads to compete with the compressed pricing and ease of execution now available with the mezz lenders. All of this has resulted in a significant decrease in the marginal cost of capital between a 65 percent LTV and 85 percent LTV deal over the past year.
While the fiercest competition and best pricing continues to be for downtown transactions, lenders are also looking to the suburbs to find yield and win deals. The biggest changes can be seen the further you move from the city and out toward the 495 loop. Previously lenders had been reluctant to jump into these markets, taking a wait-and-see approach on the market recovery. Now, as the rent recovery is in full swing in the close-in suburbs, lenders are ready to make their bets on deals further out.
The lender profile here will be significantly different. Life insurance companies that can often provide the most attractive financing in CBD assets won’t play here. On the other hand, CMBS lenders thrive in these markets providing up to 75 percent LTV for stabilized assets.
Some banks and finance companies will also play in these markets, providing a lender pool for limited value-add transactions in these markets as well. As expected, the financing terms in these markets will be more conservative with lenders looking for slightly lower leverage and higher in-place metrics as well as a rate premium over transactions closer to the city.
Whether stretching for leverage or geography, the one constant is that sponsorship is critical to these lenders. Eager to deploy capital in the Boston market, lenders are willing to take some risks, but only with high-quality clients. As competition for core deals continues to heat up, look for more lenders to try to win deals by following experienced sponsors out of the city and up the leverage curve.
In this environment, having the most timely information on the quickly moving lender landscape and driving competition are critical to achieving the best financing terms.
Heather Brown is senior vice president at JLL, and may be reached at heather.brown@am.jll.com.
