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CRE Finance World, Summer 2014

The Incredible Shrinking High-Yield Debt Market he lead-up to the 2008 financial crisis was marked by a proliferation of high-yield debt vehicles, as investors sought to capture some extra yield at a time when spreads of fixed-income products were at historical lows. Much of this high-yield debt took the form of junior tranches of large structured loans that were used to fund multi-billion dollar mega-deals. High-yield investments are coming back in vogue once again. However, there are differences in the way investors are approaching high-yield debt today as opposed to 2005-08. One such difference — a theme at the CRE Finance Council’s High-Yield & Distressed Realty Assets Summit, held in New York in March — is that a greater number of investors are looking at small-balance investments. Not only did the summit devote a panel to the fledgling “Single Family Residential Securitization” market, but other panels were sprinkled with investors who are active in smaller investments and secondary markets. Panelists said that there are good reasons to look at smaller deals. For one thing, smaller deals have less competition, which leads to higher returns. Another advantage is the number of available deals, since the total amount of commercial real estate valued at less than $10 million exceeds the size of the market above $10 million. “The challenge is to put out money without taking too much risk. How do you do that? You avoid the pack,” said panelist Billy Procida, whose Procida and Funding Advisors operates the 100 Mile Fund, which focuses on small-balance transactions between $3 million and $10 million. “When money is as available as it is today … you have to find a spot that the big guys are afraid to play in.” To be sure, big institutional players are likely to keep their focus on financing large properties. Billion-dollar funds won’t get far investing in increments of $10 million and less. And as the overall commercial real estate market gains steam, larger deals are getting done again. But the ranks of players in the small-balance market are growing, and includes a number of executives who originally came from the institutional capital markets. CRE Finance World Summer 2014 20 The most obvious example of this trend at the moment is the single-family residential space, an opportunity that was created by the huge number of foreclosed homes that went vacant during the late-2000s housing bust. A number of institutional investors, led by Blackstone Group, Colony Capital and REITs American Homes 4 Rent and Starwood Property Trust, saw the crisis as an opportunity to buy homes on the cheap. Jade Rahmani, a vice president at Keefe, Bruyette & Woods, said institutions have invested more than $20 billion to buy some 130,000 single-family homes. Last October, Blackstone kicked off the first REO-to-rental securitization, which is backed by $479 million of debt on single-family rental homes it owns. Rahmani estimated that the potential exists for up to $30 billion of annual securitization of single-family rentals. Questions abound as to performance of the product and the long-term viability of the business model. Eric Thompson, senior managing director at Kroll Bond Rating Agency, noted that when rating single-family rental deals, the agency has to address both the commercial risk related to stability of individual property leases and the liquidation risk related to the value of the homes. The lack of an established track record for the product makes it difficult to calculate sustained cash flow, Thompson said. Other concerns about the business model center around whether owners can control the cost of capital expenditures and how property vacancies affect the value of homes. Unlike commercial buildings, whose value and liquidity is determined in large measure by cash flow, residential homes might be even more liquid when they are vacant, said Randy Johnson, a director of structured credit at Deutsche Bank. FirstKey Lending CEO Randy Reiff remarked that Blackstone’s role as the issuer of the first deal may give bond investors an unrealistic view of the single-family rental market, since follow-up deals will likely be smaller and encompass less-sophisticated borrowers. One of FirstKey’s lending programs targets small borrowers that own four or fewer properties, which constitute the vast majority of single-family landlords and historically have had limited access to financing. T Paul Fiorilla Co-Managing Editor CRE Finance World


CRE Finance World, Summer 2014
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