Yesterday I received an email advertisement from a commercial loan company offering senior stretch financing. Huh? I've been making commercial loans for 34 years now, and even I was thinking, "What on earth is senior stretch financing."
Fortunately, Michael Hoffenberg, Founder and Managing Principal of Trevian Capital, was kind enough to explain it to me: "George, instead of the borrower obtaining both a garden-variety CMBS first mortgage and a separate mezzanine loan from a different lender, senior stretch financing is one loan priced similar to the blended rate of the first and the mezz."
Confused? Let me translate this from commercial mortgage-ese into English. As you know, a permanent loan is simply a commercial loan in a first mortgage position that has some amortization (usually based on a 25-year amortization) and a term of at least five years. Because of the massive commercial loan losses suffered by most commercial lenders during the Great Recession, most permanent lenders today will not exceed 60% to 65% LTV.
Sixty-three percent loan-to-value financing is simply not enough leverage for most commercial real estate investors. Therefore, the modern trend is for the investor to record a mezzanine loan from another lender simultaneously with his new permanent loan, thereby bringing the capital stack up to, say, 75% loan-to-value. (I'll translate this into English for you too in just a minute.)
What is a mezzanine loan? A mezzanine loan is not a real estate loan. It's not a mortgage. A mezzanine loan is a personal property loan secured by the stock* of the corporation* that owns the real estate. If you own 100% of the stock of the corporation that owns a huge office tower in New York City, then you own the office tower.
By the way, personal property is defined as anything that is not real property - such as cars, boats, furniture, sewing machines ... or fifty shares of stock in IBM.
* To keep this article simple, I will be using words like "stock" and "corporation". In real life, most large commercial properties are owned by a single-asset limited liability company ("LLC"). In an LLC, the ownership units are called membership interests, but its easier to just think of membership interests in an LLC as shares of stock in a corporation.
Okay, we said above that a mezzanine loan is simply a personal property loan secured by the "shares" of the "corporation" that owns the property. Why not just make a garden-variety second mortgage? Because it takes far too long to foreclose! It once took Blackburne & Sons over 17 months to foreclose a mortgage in New York. Yikes!
In stark contrast, you can execute (foreclose) on personal property in just a matter of weeks. Think about your car - another form of personal property. If you missed your car payments, would the bank wait 17 months to pop (repossess) your car? Heck, no! They'd catch you in less than six weeks, going to the bathroom at McDonalds, and drive away with your car before you got back. In my youth I used to pop cars. It was scary ... but very exhilarating. You never know if you're going to get shot or cracked open by a baseball bat.
So using mezzanine financing, a junior lender can pop a $100 million office tower in less than two months.
Okay, before we finally reach senior stretch financing, let's look at how the Big Boys might finance the purchase of a $100 million office tower. Some conduit lender might make a $63 million CMBS first mortgage at, say, 4.5%. Then a separate finance company might make a $13 million mezzanine loan, bringing the total amount of outside financing - the capital stack - up to $75 million. The buyer would then put $25 million down.
The interest rate on the $13 million mezzanine loan might be 12.5%. Twelve-and-a-half percent interest sounds horrible, until you think about the $63 million first mortgage that the buyer gets to enjoy at just 4.5%. The borrower's weighted-average cost of funds is only around 5.95% - a historically very low rate.
Now we are finally ready to talk about senior stretch financing. Some portfolio lender might look at this deal and say to himself, "Gee, the buyer is putting down $25 million. He's not gonna just walk away from the property. If I make just the first mortgage, I am only going to earn a lousy 4.5%. But if I stretch my loan amount to the full $75 million, I'll bet I could get this borrower to pay me a whopping 5.95%. It's a good deal. I'm gonna stretch on my first mortgage and just eliminate the need for any mezzanine loan at all."
And that, folks, is senior stretch financing. You can apply for senior stretch financing by simply using C-Loans.com and asking for a large first mortgage.
But folks, exotic loans like mezzanine loans and senior stretch loans are for the Big Boys. Most mezzanine lenders have a minimum loan of $5 million, which means the underlying first mortgage is probably going to be at least $12 million. Therefore, unless the property you are trying to finance has a purchase price of close to $20 million, structured finance is not going to help you. Structured finance includes mezzanine loans, preferred equity, venture equity, and senior stretch financing.
Fortunately there is a solution. Blackburne & Sons is the only small balance preferred equity provider in the entire country. We will make preferred equity investments as small as $100,000 - which allows small investors to buy small commercial-investment properties.
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