I was presented with preparing the first analysis of the acquisition of a pool of mezz loans. How should I go about doing this? I've only mostly worked on the single asset equity side, not sure what to look out for. Any help? Thanks.
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Just some basic advice. First and foremost, who is the sponsor for each loan? What is their reputation and what is their track record? If you have a deal that looks beautiful on paper but the sponsor has never really been there before, or they are known to be difficult or stupid, it might not matter.
If the loans are covering cash flowing properties:
See what the true debt coverage ratio is as well. Is everything comfortable? How much of a drop in revenue before they start getting impacted?
What is the condition of the assets? Will they need major capital work in the near future? If so, have they budgeted for it? Is a key tenant's lease ending within the term of the loan or near to it?
If the mezzanine loans are for development projects:
Do you want to control this deal at the implied value of the loan? Put another way, would you move forward as equity if the deal was presented to you?
Do you have the desire and capacity to step into the developer's shoes if they screw the deal up?
Where are they in the development process and how is it looking? Are they under construction and on budget? Is it still the planning and entitlement phases? This will be a key determinate of risk for each loan.
Do you like the market they are going to be delivering the product to? What does the pipeline look like? Are prices rising or falling? What numbers will they need to hit to be able to take you out?
That's about it for me at the moment. Hopefully some other people can chime in. The key with debt is be paranoid and pessimistic. Someone else is driving the car.
Ben-U provided some good insight.
My preferred method of analyzing these deals, assuming it is a performing-loan portfolio, is to start by creating a table, laying out investment highlights per loan, per geographic region, and for the aggregate portfolio. The table should include rows per loan (with totals / wtd avg on the geographic region and portfolio-level at the bottom) and have the following info per loan in the columns to the right: - MSA or city / state, - Geographic region - you'll want to see your exposure to certain regions and eventually take a deep dive on the largest concentrations to the extent you move forward - Deal type - construction, transitional, or stabilized - Business plan status - how much risk is there in executing the remainder of the business plan (see Ben-U's post) - Sponsor/operator - you'll want to see your exposure to different ones and take a deep dive on the largest concentrations to the extent you move forward - Sources - mortgage, second mortgage, mezz, pref, and common - broken out by funding to date and remaining future funding (as Ben-U mentioned, if there is large future funding remaining, you want to feel comfortable with stepping into ownership shoes and funding all remaining dollars... ignore guarantees at this point in the analysis) - In-place and stabilized values - compare these to current/fully funded loans on a last dollar exposure basis - T-12, in-place, stabilized NOI and resulting DSCR and debt yields to the last dollar of each non-common equity security - you'll obviously want to focus on the mezz, but also be aware of any potential stress in non-common equity securities that are subordinate to your investment - Coupons (or YTM if buying at discount to par) - fixed/floating, benchmark rate if floater as well as benchmark floors and caps, spread if floater or interest rate if fixed - you'll want to pay attention to deals that are floaters to ensure that over time the loans can maintain positive coverage ratios - IO / Amortization details - this ties into the prior bullet, as amortization commencement can lead to unraveling of stress in bad loans - Spot and exit market cap rates - compare to debt yields - Occupancy rate versus market occupancy rate - helps gauge where sponsor is in business plan execution and shows you remaining "value-add" in a deal - In-place rents versus market rents - helps gauge where sponsor is in business plan execution and shows you remaining "value-add" in a deal - NOI margins versus typical stabilized margins per the product type - helps gauge where sponsor is in business plan execution and shows you remaining "value-add" in a deal - Initial maturity, remaining term, and extensions - Prepayment methodology, if applicable - regardless of the YTMs to the mezz, you don't want to spend time on a portfolio investment only to have a bunch of payoffs months later with no prepayment penalties
This might seem like a lot of info, but is helpful/necessary to digest the large amount of data that comes with these portfolio deals.
many thanks to both you and ben-U for the thorough responses - truly appreciate you guys taking the time to write this. how would your above framework differ if the pool were non-performing?
To jump ahead of REAquisitionsnyc, how many loans are we talking about? The framework and approach for a pool of 5 should be different than a pool of 50. Also, are the deals and mezzanine piece similar for each deal? If it is 50 loans but 10 of them make up 80% of the value you will take a different approach still.
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