Come on in: An interview with Wachovia's Commercial Real Estate Team

RMA Journal, The,  June, 2003  by Jim Nelson,  Beverly Foster

Tags: commercial real estate, Wachovia Corp.

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We've seen some deterioration in our portfolio, but I don't think it's going to be a large problem unless there's a significant spike in rates without a corresponding change in the job situation.

Jim: We've seen NOI going down, but as mentioned earlier, cap rates have been declining basically in tandem, resulting in little effect on the property values. I've been hearing that cash flow is still going down, but those cap rates seemingly have flattened out, which will affect property values. What are your thoughts?

Bill: I don't think cap rates have flattened out. For the most part, we're seeing more activity at lower cap rates, which is affirming for lower cap rates. But statistically, cap rates are at some of their highest levels ever relative to risk-free rates--300 and, in many cases, 500 basis points higher than the 10-year Treasury. That's never happened before; arguably, from a statistical standpoint, cap rates should be much lower.

Mike: We still see a lot of money on the sidelines waiting to enter, and there doesn't seem to be much pressure on cap rates to go in the other direction. Rather, we've found that property today has a higher vacancy rate and a lower NOI than a year ago, yet can fetch more money in the marketplace than it could a year ago. I suspect that needs to reverse itself a bit or at least flatten out over time.

Bill: We deal with all sectors of debt--bridge, mezzanine, and equity co-investment. The senior debt can be the most risky component in a lot of transactions. For example, we're about to put a very unpalatable proposal on the table for a buying group. They are paying more than $75 million for an asset; the property has a single tenant, who is an A-rated credit, but the lease is for just 10 years. We are coming in at the $40 million range for the senior debt. We are very comfortable with $20 million of 10-year, self-liquidating subordinated debt behind this senior debt, since its repayment fundamentally comes from the credit of the tenant. The balloon amount for the senior debt is the rub, though, as it will still be a very high exposure on a potentially empty building (north of $150 per square foot). My guess is that another lender will take comfort in a simpler structure, with a much higher senior debt level. So, in this example, we love the mezz and we struggle with the senior debt.

Jim: This is a goad point to discuss mezzanine lending.

Bill: We do both mezzanine and equity co-investment. We are not a huge player in it; most of the mezzanine market is still done in private equity and opportunity funds. The large public funds and private funds tend to make large, chunky bets. I think we are a little more granular in our approach. What is surprising, though, is where we tend to compete--not with The Street, where mezzanine money starts at $25 million and up, but with small regional banks that, in our opinion, tend to misprice the risk. If we put together a 65% senior and a 25% mezzanine transaction, our combined cost of capital could end up being 50-75 basis points higher than that of a small regional bank.