Pearlmark, a Chicago-based real estate private equity manager, has closed its latest opportunity fund at a time when the need for gap financing is waxing.

As published from Real Estate Capital USA, February 2, 2023, Doug Lyons shares his commentary.

The $210 million Mezzanine Realty Partners Fund V will focus on mid-market lending opportunities, says Doug Lyons, a managing principal at Pearlmark. The firm also has co-investment relationships, bringing the fund closer to an estimated $500 million total in deployable capital for any mezzanine opportunities arising in 2023.

“Our bread and butter is really providing $5 million to $25 million mezzanine loans, with the capability to do a larger mezzanine alongside co-investment capital where we seek to deploy,” Lyons says.

The fund’s main priority is to originate loans secured by partnership equity with a senior balance sheet lender in the first mortgage position and a market-standard inter creditor agreement between the deal participants. While the firm has looked at some B notes and preferred equity opportunities, Lyons says the vast majority of what Pearlmark is looking to deploy is in the mezzanine space.

Multifamily focus

Pearlmark is cautious on office and retail intentionally and its prior strategy –Mezzanine Realty Partners Fund IV – was intentionally weighted toward multifamily for this reason. The firm is targeting traditional multifamily acquisitions and multifamily construction opportunities with the new fund, as well as subsector opportunities in the student housing market.

“Historically we have been active in office but right now we are still very cautious there,” Lyons says. “We have done only one acquisition financing of office in our current Mezz Fund V but at a very low loan-to-acquisition cost with additional collateral in land for multifamily development associated with that financing.”

Akin to its prior fund, Pearlmark is shying away from big box retail, power centers and malls, with retail exceptions made for select grocery-anchored mezzanine opportunities.

“We continue to be very conservative in terms of our approach to underwriting, and when you look at Mezz Fund IV and how we successfully navigated covid-19 with zero exposure to hospitality and minimal exposure to office and retail, we have done quite well,” Lyons says. “Our focus on multifamily has paid off.”

As Pearlmark stands today, the firm is looking at 75-80 percent last dollar exposure, with willingness to go up to 85 percent last dollar. This is driven partly by Pearlmark’s underwriting and how the firm has pushed out its exit cap rates and pulled in growth rate assumptions on rents, Lyons explains.

“As we are looking at prospective loans to stabilized value at a maturity date, we are looking at wider targeted debt yields than we had in the past, typically above a 7 percent debt yield on a multifamily asset,” Lyons says.

As a mezzanine lender, Pearlmark will be subordinate to senior balance sheet lenders. Lyons sees attachment points – the part of a capital stack where a senior loan ends and a subordinate loan begins – of about 50-55 percent. This is a decline from attachment points of 60-65 percent of markets past.

Looking ahead

Looking to future opportunities with Pearlmark’s Mezzanine Realty Partners Fund V, Lyons says the firm has had a lot of success with insurance companies where it can structure direct participation on new deals, and looks to emulate this further.

“In the construction mezzanine area, we are seeing some larger mixed-use projects where that gap finance is critically important,” Lyons says. “We have seen some sizable opportunity zone developments where the sponsorship is taking a longer-term perspective.”

Additionally, Lyons notes more real estate private equity firms have expressed a high level of interest in co-investing in larger mezzanine loans after essentially rediscovering gap finance during this period of distress.

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