Lenders launch bespoke lending programs to tackle funding gaps 

Red Oak Capital, Pensam, and Tower Capital are among the managers rolling out or expanding customizable programs. 

A growing number of commercial real estate lenders are rolling out bespoke lending programs to target what they see as short- and medium-term opportunities to creatively fill the gap in the capital stack for borrowers facing maturities. 

The rising rate environment has meant many senior lenders have reduced leverage and projects are bumping into minimum debt service coverage and debt yield requirements from lenders, explained Adam Finkel, founder of Scottsdale, Arizona-based advisory Tower Capital. 

“As interest rates continue to rise, as borrowers are coming out of construction or bridge loans, a lot of folks will have challenges replacing existing debt. The rates are much higher than their initial rates, cap rates are higher, and values are lower. This happened quickly, without giving folks time to adjust,” Finkel said. “The program will allow deals to pencil in a period of market volatility when debt is still cheaper than equity.” 

Grand Rapids, Michigan-based manager Red Oak Capital sees a similar situation in the market, with the firm launched or expanding four new lending programs that can be tailored to the specific needs of owners, developers, and investors, said Gary Bechtel, chief executive officer.  

The firm’s new programs include four bridge lending strategies, with Bechtel explaining Red Oak is seeing substantial inquiries from borrowers with short-term issues. The programs include a participating bridge loan program, an opportunistic bridge loan program as well and core and core-plus lending strategies, Bechtel explained. 

“Our timing could not have been better, given what has been going on in the market over the past 90 to 180 days. The bridge market, at the beginning of the year was really being driven by floating-rate lenders who were using a CRE CLO securitization execution for their loans. That market is completely gone – there is little investor demand – and we have seen that business flip back to fixed-rate, balance sheet lenders like us,” Bechtel said.

As a discretionary provider of commercial real estate capital, Red Oak can provide short-term lending programs through which it can work with borrowers on structure. The firm is a fixed-rate, balance sheet lender that raises and invests capital via several buckets, including through its broker-dealer channel and a series of real estate private equity funds.

While the pricing is a little wider than similar bridge lenders for its opportunistic bridge loan, the firm can get creative within its structure in which it can go up to 90 percent of cost against a 65 to 75 percent loan to stabilized valued. “We’re providing an equity component within the confines of a debt structure,” Bechtel added. “We are seeing a lot of borrowers who have deals that have a lot of lift, which means including reserves for rehabilitation.” 

Red Oak’s investors are a mix of high-net-worth and institutions, with its core programs geared more toward institutional investors. “The money we raise into Oak Institutional is deployed into lower-risk bridge loans, projects with enough cashflow to service the debt and either more money or time for the borrower to decide what to do with an asset. Our core-plus deals are for properties that have some lift, like re-tenanting or rehab, and are not covering debt service,” he added. 

This level of customization is something Tower Capital is running into as well. Through the program, the firm will help to structure preferred equity investments that will allow borrowers to push leverage back into the 85 to 90 percent loan-to-cost range. These could be opportunities in the construction or value-added markets, Finkel said.  

The firm is looking for opportunities in the build-to-rent, multifamily, industrial and limited-service hotel sectors. It will consider some opportunities in the retail and office sector. 

“We are in the kind of market where if a sponsor doesn’t have to refinance, they won’t seek to,” Finkel said. “We are already doing some recaps on construction loans where there wasn’t enough interest reserve accounted for and there are cost over-runs. Trying to negotiate that with an existing lender can be really challenging.” 

One solution in situations like this is to recapitalize the property by taking out existing debt and providing additional capital to complete a project, potentially with secondary financing like traditional mezzanine debt or preferred equity. “We are also seeing lenders offering soft versus hard preferred equity, depending on the rights the lender negotiates with the equity investor,” Finkel said.   

Preferred equity is different from mezzanine debt in which the relationship between the senior loan and the mezzanine loan, a second lien on a property, are governed by an intercreditor agreement. “There is no second lien on a property with preferred equity, but even with that, there is going to be an agreement with the senior lender and the preferred equity investor to say something like, ‘If the sponsor defaults, please kick it over to us and give us more time to remedy this,’” Finkel said. 

The outlook is that there will be more need for mezzanine debt and preferred equity, particularly at a time when rates are rising, and lenders and borrowers are still hesitant to move ahead with projects because of uncertainty in the financing markets.  

“I think once the rates do level off, even if they stay elevated, it will be easier for people to underwrite, make decisions and feel confidence. We are just not there yet,” Finkel said. 

Pensam Capital, a Miami-based private real estate debt and equity investment firm, recently originated a $7.6 million preferred equity financing for the recapitalization of The Elise, a 341-unit apartment community in Dallas. This investment fits in well with Pensam’s broader strategy of allocating capital into the multifamily sector where it has investments in a portfolio of roughly 40,000 units.

The firm funded the loan on behalf of sponsor Windmass Capital, who arranged senior financing with a senior lender and then sought out Pensam for incremental capital to complete its financing needs. “Pensam was able to increase total loan proceeds up to 75% of the capital stack, a significant increase above the senior loan,” said Ray Cleeman, Head of Capital Markets and Lending at Pensam.

“While we don’t have a crystal ball, the Federal Reserve has messaged that there will likely be further rate hikes in the near term and that they will likely keep rates elevated for longer than was initially anticipated,” said Cleeman. “The confluence of today’s higher borrowing costs, which translates into lower senior loan proceeds, combined with a wall of near-term maturing loans that are mostly higher leverage loans taken out in a much lower rate environment, will likely lead to senior loan shortfalls in capital stacks on both new deal acquisitions as well loan refinancings, even if the deals are performing well.”

Cleeman said that Pensam’s activity has been incredibly strong since rates have ticked up these last few months and they expect their volume of transactions to increase their pace over the next few months. The firm has what Cleeman described as a very deep pool of capital ready to deploy for these types of deals.

“Over the last few years, the multifamily sector has been characterized by higher leverage senior loans that were readily accessible due to the lower interest rate environment. Now with the incredible acceleration of interest rates, SOFR being over 4.15% and the 10-year Treasury over 3.5%, it is difficult for deals to pencil out at the same higher leverage points and this leads to compressed senior loan proceeds,” Cleeman said. “With the reduced available senior loan proceeds, sponsors will likely have shortfalls in their capital stack and will require preferred equity or mezzanine financing to round out their capital stack and that is where Pensam fits in.”

He continued: “There will be an incredibly high level of demand for the kind of incremental capital, both preferred equity and mezzanine financing, Pensam offers over the next few quarters, and we will have to wait and see what happens when the Fed takes its foot off the pedal to provide interest rate relief.”