Recent activity in the real estate markets has consisted in large part of the sale and acquisition of commercial mortgage and mezzanine loans. The pre-downturn prevalence of CMBS financings at high leverage levels has given the holders of commercial real estate loans significant control over the trading of commercial properties; a property that will not sell for more than the debt stack simply cannot be disposed of outside of bankruptcy absent some concession from one or more lenders. As a result, in recent years savvy real estate investors looking for access to properties began to acquire mortgage and mezzanine loans (and co-lender interests in those loans), initially at very attractive pricing that strongly enhanced projected returns. As the market in real estate debt has strengthened, the pricing advantages seem to have diminished to some extent.
Investors in the secondary market for real estate debt may have different goals. Some investors (though fewer as pricing has firmed up) acquire debt for the return, seeing recovering real estate values and any discount to par as creating favorable yield opportunities. Others are making these investments, occasionally at a premium to value, as a way to obtain control over the debt stack at the ‘fulcrum point’ (i.e., the most junior position in the debt stack that is that is at least partially “in the money”), since that position typically controls lender decisions under the applicable intercreditor arrangements and is also optimally situated to be the successful bidder in a foreclosure sale.
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