Pearlmark is tilting its newest mezzanine fund toward multifamily opportunities to capitalize on appetite for ground-up and existing properties while steering away from perceived headwinds in the office sector in large capitalization markets such as New York, Chicago and San Francisco.
Doug Lyons, managing principal at Pearlmark, told Real Estate Capital USA that the Chicago-based private equity and real estate boutique is carving out new multifamily deals in Florida, South Carolina, Texas and Northern California as part of its push to match appetite for the in-demand asset class.
“For us, the multifamily asset class is not going to go away,” Lyons said. “You need to be sensitive to new supply issues in certain sub-markets, which could throw the supply-and-demand fundamentals out of whack and create situations where you might see concessions come back into the marketplace. But over the many decades and cycles that I’ve been in this business, multifamily has generally held up pretty well.”
Near-term mezz priorities
The firm’s $150 million Mezzanine Realty Partners Fund V is currently on pace to register $300 million to $400 million in funding before its second quarter 2022 close. Lyons said the firm spent 2021 primarily focused on capital formation and saw interest ramp up in the latter half of last year after pandemic-driven hindrances on commercial property sales and refinancing opportunities eased up.
Insurance companies in particular helped fuel second half 2021 momentum for the firm, and private debt funds originating senior loans laid the financial groundwork for Pearlmark’s closing on the first two investments into its mezzanine fund, including a Class A apartment complex in Bradenton, Florida and a student housing property at the University of South Carolina.
Lyons said the firm prefers new multifamily assets and would rule out a value-add play on the lending front, though Pearlmark’s equity arm is active in value-add multifamily investing.
The firm recently approved construction financings for ground-up multifamily projects in Dallas and San Antonio as part of its mezzanine funding roadmap. Pearlmark also has a student housing project in Michigan going through due diligence and is working out a refinancing deal on apartments in Northern California.
Lyons said Pearlmark has been finding more opportunities to participate in the market as a gap financier, exemplified by its Northern California apartment deal where the firm is providing gap funding to get the asset up to 80 percent of its underwritten value with room for more value-add options remaining in the business plan.
“We are seeing situations for gap financing on refinances as well,” Lyons said. “Often it’s a maturing construction loan where the property isn’t fully stabilized, and the developer does not want to sell or refinance based on where the cashflows are, so they look for a new senior lender and possibly gap financing provided by mezz to accommodate a recapitalization.”
The gap refinance opportunity is seen most visibly in Pearlmark’s student housing recapitalization in Michigan, according to Lyons.
For that asset specifically, he said there is a longer-term fixed-rate insurance company permanent loan in place prohibiting a refinancing but allowing mezzanine debt to let the developer avoid having to pay significant call protection or yield maintenance by keeping the senior loan intact.
Looking beyond multifamily
Lyons said the firm would like to capture some industrial exposure with its next wave of mezzanine financing opportunities, but noted that high valuations and fast absorption rates of new supply make it a struggle to guarantee Pearlmark’s targeted returns.
Pearlmark is angling away from select portions of the office sector as part of its mezzanine funding roadmap as it digs deeper into multifamily. “We’re going to avoid the large capitalization, urban, heavy mass transit markets for a little while to sort out where companies decide they want their occupancy requirements to be with folks either coming back to the office or on flexible work schedules.”
Lyons said to the extent Pearlmark is looking at office opportunities, it will aim for growing Sunbelt markets such as Nashville, Charlotte and some markets in Texas.
Pearlmark is staying cautious on hospitality and selective on grocery-anchored retail while redlining big-box retail and for-sale residential to round out its strategy, according to Lyons. The firm notably did not sign any hospitality business among the 17 investments made through the Mezzanine Realty Partners Fund IV during the onset and early quarters of the covid pandemic.
For its general business strategy, Lyons said Pearlmark plans to stay active in mid-market value-add equity strategies and focus on high-quality sponsors, institutional-quality assets and hone its mezzanine lending capabilities in tandem with senior balance sheet lenders on the credit front. “We’re not going to stretch on advances,” Lyons said. “There are some people out there going up to 90 percent; that’s not for us.”
Pearlmark is currently in the process of switching loan servicers atop the capital formation happening with its fifth mezzanine fund structure. Lyons said the decision on its next servicing partner is set to be finalized soon.
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