Hines sees room for mezz, pref equity growth as bank lending tightens

Hines has its sights set on gaining more commercial real estate financing ground, with eyes on mezzanine debt and preferred equity deals, as bank lending recedes on account of elevated interest rates.

The Houston-based real estate investment manager is looking for new financing opportunities beyond its traditional equity and development gearing as industry repricing has forced more portfolio introspection and strategy recalibration for firms across the commercial real estate debt universe.

Alfonso Munk, Hines’ chief investment officer of the Americas, told Real Estate Capital USA the firm is not aiming to become a senior lender but is exploring options it is more comfortable with, such as taking mezzanine or preferred equity positions on high-quality assets where sizable balance sheet lenders and banks need the coverage.

Munk said plenty of big lenders – be it banks, insurance companies or debt funds – have come to Hines with portfolios or assets hitting headwinds, such as a challenged office asset or multifamily asset acquired for an outsized premium. In what Hines labels ‘broken developments,’ such lenders are calling the firm to come in as an equity investor to help redevelop the asset, take it over entirely, help a lending partner manage it or place some debt on the asset.

“Investors are cautious, but optimistic,” Munk said. “The ones that are going to be having a tougher time are going to be those investors and managers that were highly dependent on debt to make their numbers work.”

Munk said the group of market participants who were using leverage-free money at zero percent interest rates to offer extraordinary returns is going to disappear. “I would not be surprised as a result of this cycle, this resetting of the market that we are seeing, that managers are going to disappear from the marketplace,” he added. “There’s going to be small and medium-sized investors that are going to be wiped out because they were really levered players and that game is over.”

He said such a reckoning could materialize in the next 12 to 24 months, based on prior corrections that have adversely affected investor pools.

David Steinbach, global chief investment officer at Hines, said in the firm’s 2023 outlook report that the market is in “the opening innings of a new chapter of investing.”

He said investors waiting and hoping for rates to change may ultimately be proven to have chosen a poor strategy. He noted that the market is correcting and now is likely the time to shore up assets. “While it is difficult – and probably too early – to call a bottom, cost averaging down has proven a successful strategy during previous downturns,” he said. “Eventually, more accretive opportunities are likely to emerge.”

Underlying the US

In his section of Hines’ latest report, Munk said the market is entering what is likely to be the most difficult part of the cycle for tactical investment opportunities.

In the summer of 2022, Hines saw evidence of pricing declines of 25 percent with the number growing to 40 percent by the fall. In select cases, price discovery was made moot by a thinner lender pool.

“With interest rates continuing to climb, capital markets have been dislocated,” Munk explained in his 2023 outlook. “The general upward pressure on interest rates and instability in the market has challenged underwriting for both acquisitions and development as negative leverage is pervasive and widening.”

Lender availability and willingness – at a minimum among some of the biggest balance sheet bank lenders – is adding more pressure on other market participants to either step up and fill the capital void or go along with the pause while conditions are difficult to justify.

Munk said Hines is looking toward the office sector for new opportunities should a wave of distressed assets seeking workouts or facing defaults materialize in 2023. He explained that the amount of loan maturities in 2023 – which are expected to roll at lower loan-to-value levels and higher all-in rates – is prompting Hines to look for funding gaps to widen, generating capital needs and creating opportunities for those with dry powder to invest.

In tandem, Hines is also seeing potential deals to be made with investors who acquired assets with short-term financing, credit lines and bridge facilities, which will face more difficulty obtaining permanent financing, and therefore, maintaining capital gains. “We will be on high alert to take advantage of distressed asset sales and projects with refinancing issues,” he added.

Akin to other debt market participants, a period of disruption like the current one is viewed as a period of opportunity during an economic downturn. “The investments that should be the safest will be those that have a favorable risk profile, construction pipeline or supply constraints, a strong core score and a realistic pricing discount,” Munk noted.

He explained that generating outsized returns in the current market will require more active management and operation of assets, especially with the information gained by working directly with tenants that leads to more value-enhancing plays.