ArrowMark Partners: Straddling debt and equity in the mid-market

As the US commercial real estate market faces a wall of loan maturities – over $1.5trn over the next three years – taking a creative approach is highly important, says ArrowMark Partners’ Rob Brown.

This article is sponsored by ArrowMark Partners

Rob Brown, portfolio manager and head of real estate at Denver-based ArrowMark Partners, believes it is important for commercial real estate managers with debt capital to deploy to take a flexible and creative approach in today’s volatile market.

Speaking to Real Estate Capital USA, Brown notes that ArrowMark has been transacting even as the market has changed dramatically over the past several months. “Given the rapid rise in interest rates and this unforeseen banking crisis, today’s market has a lot of volatility and fear. We are finding that our phone is ringing more, and our dealflow remains robust,” he says. “Because we have a balance-sheet centric, non-capital markets driven platform, we can be open for business. That was the thesis when we created the platform and our various lending strategies.  We wanted to be built to last through all real estate cycles and survive capital markets volatility.”

Interest rates have been rising steadily for more than a year now. How has this impacted your sponsors?

Rob Brown
Rob Brown

The reality of interest rate movements is currently the top of the list in terms of the conversations that we are having in real time with our sponsors. Our industry has expected interest rates to move and has been talking about it for more than five years, but I don’t think that anyone anticipated rates to move as quickly as they did. Today, we are finding that a lot of groups are caught in that reality.

This has meant we have had to be creative and provide capital solutions to address the circumstances we are living in right now. A good example of that is being able to provide fixed-rate financing at a time when sponsors don’t want to take out floating-rate loans. Interest rate hedging cap costs are real, and we can provide a borrower with a three- or five-year fixed-rate loan with prepayment flexibility. Structures like this allow borrowers to get through these volatile times and to a place where they can sell, refinance or recapitalize a loan on the backend when markets are calmer and borrowing costs have declined. As a balance sheet lender, these fixed rate solutions are differentiators, and this is something we can provide while lenders who are reliant on the capital markets and securitization to finance their product are only able to offer floating-rate loans.

What is different about being a balance sheet lender in times of stress?

We are finding that balance sheet lending is a differentiator in times like this. It is not just because we have capital that is able to be deployed, it is also about being able to have a direct call, borrower to lender or lender to borrower, which is a huge advantage in times like this. It was also a benefit, during the height of the covid-19 pandemic, that sponsors were able to call us directly and we didn’t have to speak to third-party servicers, absent stakeholders or even bond buyers.

In addition to operating a balance sheet product, ArrowMark benefits from a fully integrated asset management and servicing team that oversees our book from cradle to grave. Today, whether it is pending maturities or business plans that are likely changing, having that direct communication differentiates us from a risk management perspective but also from the borrower’s experience.

Mid-market lending means different things to different firms. How do you define the mid-market?

We concentrate on assets of about $100 million or less in value and provide both debt and equity capital to mid-market owners and operators. The business is anchored with a commercial mortgage loan (CML) origination strategy, which is our core product and we have been slowly building out other product lines and investment vehicles.

For example, we have a small balance CML program that targets loans of $1 million-$10 million in size, which we believe is an interesting niche area to focus on. While there are some insurance companies and banks who have historically been active in this segment of the market, we still find a lot of deals in this area and it’s a great product for our clients.

Another part of our CML strategy is focused on loans of $10 million to $100 million, with our strike zone in the $10 million to $50 million range. I think the interesting part about what we are doing is that we’re able to provide both fixed- and floating-rate debt. We are not a “one-product” shop, we are not a debt fund and instead are funded through various partnerships with insurance companies that we have built over the years.

What makes a good loan?

Geographically, we are investing across the US. The way we frame it is that we focus on NBA and NFL cities (and college towns). If you look at sponsorship, you will see we run the gamut between institutional owners and operators, but we also have worked with experienced entrepreneurial owners as well. These sponsors may not be large private equity firms, but they are experienced in a certain market and have a strong track record.

There is a consensus that it is a good time to be a lender – are you seeing this?

We do see today’s market as a good time to be a lender. Right now, there is a lot of volatility, and we are seeing constituents on the lending side who are pulling out of the real estate lending market. On the back of the failure of Silicon Valley Bank, we have seen that local and regional banks – who are typically strong competitors of ours in the mid-market – have really pulled back and stopped lending. In addition, the insurance companies are still lending but at much more conservative levels. This makes it a good time for a group like us because we can access better deals, borrowers, and economics. I think the CML and the CRE credit space more broadly, is entering what will be viewed as a “golden era.” Whether we are providing senior debt, preferred equity or a hybrid of the two, we are typically not taking last dollar risk and are able to deliver very attractive returns for our clients and investors and do it in a very disciplined manner.

Are more investors seeing debt as an investment?

We have been discussing our value proposition and position in the mid-market structured finance space for a long time now and it is now really resonating. This could be the greatest credit vintage since the Great Financial Crisis. Our platform is differentiated through our strategic partnerships with our insurance companies and being able to talk about balance sheet centric solutions, which we think is a real differentiator among credit real estate managers in our world.

What are you focusing on over the next year?

We will look to deploy $1 billion to $2 billion this year in the CML space, even as the acquisition and capital markets continue to be in a very slow, tough spot. We are finding that the greater real estate market is more defense than offense right now and being able to provide both debt and structured equity solutions for sponsors will be a benefit.

We have always tried to straddle debt and equity and bring a holistic approach to commercial real estate, and we are finding that is a differentiator for us. There are many groups that are either only lender or equity providers in the mid-market while we can provide both for mid-market sponsors.

Granary Square ArrowMark
Granary Campus: ArrowMark originated a loan on a redevelopment project in Salt Lake City’s Granary District in 2022

Case study: Salt Lake City

ArrowMark last year originated a loan on a mixed-use redevelopment project in Salt Lake City’s Granary District.

“The Granary District is a growing submarket that is becoming a place for people to live, work and play,” Brown says. “The building is an older factory building and the sponsor went in and repurposed it as a mixed-use project with retail, recreation and hospitality.”

The firm provided a five-year, fixed-rate loan on the property, which is a pre-stabilized asset. “The property is ramping up and the sponsor was able to use the financing to pay off a construction loan,” Brown says. While the opportunity saw interest from banks, the sponsor sought a non-recourse, fixed-rate coupon with prepayment flexibility.

“Because of our insurance company partnerships, we were able to provide a cash-neutral refinancing on a five-year, fixed-rate term. We like the sponsorship, the location and two or three years from now, they will be able to convert to permanent financing or sell the project because we were able to provide them flexible prepayment on the back-end of the loan term,” he adds.

Opportunity highlights:

ArrowMark was approached to refinance a construction loan on a recently completed adaptive reuse project located in the Granary District of Salt Lake City, UT;

The property is a 110,000 square foot mixed-use recreational asset consisting of both retail, recreation and hospitality. Its location in the Granary District with close proximity to downtown will drive foot traffic and retail demand;

The sponsor successfully redeveloped the asset from its former use as an industrial warehouse and was able to lease it to national and regional tenants;

ArrowMark provided a non-recourse five-year fixed-rate financing with prepayment flexibility which allows the sponsor to sell or refinance the project once the asset is stabilized.