Challenging refinancing in difficult market conditions can be a catalyst for growth with a strategic partner, rather than a cause for panic, writes Alex Lukesch
It is well known that the commercial real estate debt market is amplifying the headwinds in an already challenging current macroeconomic and market environment.
Property owners and borrowers need to proactively manage emerging or expected equity gaps, debt maturities and/or refinancing needs amid low liquidity and anaemic valuations.
Property owners and borrowers are finding that lender proceeds are lower than historical norms, driven by debt service coverage and LTV ratios becoming stretched amid falling valuations and interest rates remaining higher for longer.
To improve these key lending metrics, oftentimes an equity injection is needed as part of the refinancing process.
Borrowers then have three options: inject equity from their own balance sheet; sell the entirety of the asset or portfolio; or bring in a new partner which can take many forms depending on the capital needs of the investment and the availability of debt, ranging from a mezzanine lender to preferred or common equity.
For years, Madison International Realty has specialised in coming into existing partnerships or ownership structures, helping solve liquidity needs as outlined above. We have always sought to enter an investment structure as a common or preferred equity partner, and be a long-term liquidity solution.
These transactions are known as direct secondary investments, where a firm provides an equity injection into existing investments and structures to help sponsors of properties and portfolios achieve their business plans.
This could come in the form of aiding capital shortfalls during refinancing events as outlined above or providing additional equity for the continued growth of the investment or portfolio.
Given this involves entering into existing investments and business plans, we believe this type of investment is inherently more defensive and risk-mitigated than other strategies.
With this backdrop and in considering current market conditions, we believe a plethora of opportunities will develop over the next few years.
The advantages to the existing owners are numerous. First, they do not have to inject their own capital into the investment vehicle, which they may not be able to do due to structural limitations like a fund being beyond its investment period or it could be dilutive to other ventures they may have.
Furthermore, current interest rates make it significantly less attractive to inject your own equity into an investment.
As a result, this potentially requires a significant amount of capital that may be financed with expensive debt. We believe the alternative of bringing in a like-minded partner that reconfirms the investment thesis is a more attractive solution.
Second, investors and borrowers are not forced to sell their investment outright during a period of depressed market valuations or before they have completed their business plan.
A secondary partner can allow them to be more strategic in determining when to crystallise returns for their investors. It is also a way to grow the platform or portfolio further if they feel there is still meat left on the bone.
Borrowers facing a challenging refinancing situation in unfavourable market conditions do not always need to hit the panic button, but instead may find it can open a path to further growth with the right partner.
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