Right now feels like a great time to be a debt investor and a difficult time to be a core/core-plus focused equity investor over a near/medium term horizon.
Transitional debt spreads for new loans have increased anywhere from 100bps - 300+bps, which equate to 10%+ IRRs for those that lever their positions. Sure you won't hit a home run, but you'll get a great yield and almost certainty get 100% back at payoff, and even in severe distress are likely to recover most of your basis.
Equity investors need to determine a value (difficult to know right now), and if they whiff, it doesn't matter if they're able to keep it leased and collect 100% of rent over the next few years (which feels unlikely in current environment), they blew their IRR by buying at time high of a price when the market values were in flux. A lot of potential even in the low risk end of the space to miss your return threshold.
Curious to hear different opinions here, but to me it feels if you're an allocator targeting high single digit/low teen returns, the debt space would be the place to be for the time being.
Edit - just to be clear, trying more to compare transitional debt origination to core-plus acquisitions which generally are targeting the same return profile. I'm sure guys in the value-add/opportunistic field are going to have the chance to blow it our of the water here, same with guys that have been buying bonds, but that's not really what allocators in this risk space are looking to do.
I think it's the opposite. Leading up to this it was hard for equity investors to find yield as prices were quite high whereas debt guys could still find yield. However, in the next two years and beyond its the equity guys who will be able to buy distress and make a killing.
No. - Debt Guy
Are private debt funds largely getting fucked right now? Whats the underlying issue - lack of deal flow + margin calls from credit lines?
Would love to hear from someone in the space
Pretty much. Less structural protection than the banks as well. Plus they are not as liquid in a general sense to weather something like this.
Interesting topic right now... if you were considering mezz vs pref equity right now, what would be the pros and cons behind each position? The rates appear similar, both solving for a 10-13% IRR, and both have similar coupons, so is the only difference the rights?
That doesn't really make sense to me on why 1 option wouldn't almost always be better than the other, which is why i think im missing something.
Could anyone outline the exact benefits each has, ie coupon/yield, and total return (IRR) each investor is solving for (pref or mezz investor)
Come to think about it... mezz lenders lever themselves aggresivley, right? Do pref 'investors' alos? this would make a big difference in returns obviously.
In practical terms, there is little that distinguishes mezz and pref. The only real difference from an execution perspective is that the fitch model doesn't ding you for pref the way it does for mezz, so the last 12 months have seen way more mezz than pref so that people can layer this behind their cmbs debt.
Also, they don't realllllly solve for IRR's as much as they're solving for multiples, usually.
The way I see it, you are not guaranteed your basis back on a Mezz (junion) loan investment. It's a similar risk profile to pref equity, but you have absolutely no upside. I'd take the pref equity.
Can you expand on that?
Why would any mezz lender take that position in any case vs the pref?
What are the rights/protections on mezz, and what returns are they seeking, compared to pref?
Your highlights of the mezz above would suggest it has a higher risk profile, and should be lower in the cap stack; i dont think that is true, is it?
Usually Mezz has a UCC lien on the borrowing entity. They can take over as borrower on the first lien if borrower defaults them.
Thanks, I've been reading up on UCC liens... but practically, what is the difference between the 2 if with Mezz you have a lien on the borrowing entity, and with pref you take their share of equity. Both options appear to solve for the same thing - take over borrower, vs take over the equity of the borrower..... I am failing to see the fundamental difference between the two..
If the equity gets wiped out, then mezz gets to take over as borrower. It's in a safer place in the capital stack.
With Pref I am assuming that payments accrue unless current pay is not being met. Maybe triggers for current pay to accrue if not being met. SO Common equity is still running the real estate, just not paying dividends until a liquidation event. But there could be a trigger where pref takes over at a certain point....as long as you don't default on the debt common equity is fine.
What exactly do you mean by 'transitional debt'
What return would you target all-in? (return of principal, + orig fee + interest + exit fee) and how long?
How much leverage are you talking about?
Are you seeing a lot of debt funds selling loans right now? We have had great trades with 2 funds recently who needed liquidity and sold us a couple of loans just below par. Nothing wrong with the loans the fund just needed capital.
Interesting - why did the funds need the liquidity? Better priced debt that they wanted to reinvest into? Or some other reason..
margin calls
are there any fees on note sales, or just the spread?
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