DB sees mezz lending opportunities

Mezzanine debt investments provide a 'particularly attractive' window of opportunity for alternative lenders, according to a new report by Deutsche Bank.

The limited availability of debt combined with banks' high risk aversion has resulted in financing at higher LTV levels becoming very difficult. Consequently, interest rates for mezzanine loans have increased, creating an attractive spread to conservative senior loans, Deutsche Bank said.

In particular, margins for mezzanine have increased from around 400 basis points in 2008 to 700 basis points and 1,000 basis points in 2009-2011.

Although the risk associated with junior or mezzanine loans is doubtlessly higher, Deutsche Bank noted in the report that it might not be as high as suggested by the current pricing - in particular if the underlying collateral is a stabilised core property.

'On the one hand, the typical maximum LTV for mezzanine has declined over the past five years; on the other hand, the majority of markets are at or close to the bottom of the property cycle. These factors should reduce the effective risk on the lender side,' the financial institution said in the report, entitled 'Understanding European real estate mezzanine debt'.

'Our analysis of lending market conditions leads to the conclusion that mezzanine debt may be attractive on a risk-adjusted basis relative to equity or senior debt,' it added.

Deutsche Bank's analysis also shows that mezzanine remains the preferred option in various downside scenarios, and especially in cases of relative mild market distress, where it outperforms equity and senior debt.

'The former suffers directly from declining values and the latter offers very low interest in the current market environment,' it noted. In contrast, the 20%-30% buffer protects mezzanine investors from moderate market declines and high interest boosts the returns to investors.