Debt and Equity Market 2008 Predictions

Other trends becoming apparent for the year, though, are more positive. These include growing levels of equity and mezz financing stepping in to fill the void left by the CMBS markets' seizure, and new buying opportunities that range from distressed loans to emerging markets.

To avoid stalled development opportunities, or worse, overextendeddevelopers are seeking out preferred equity, mezz financing or JV partners, or a combination of the three, says Adam Petriella, senior director of Finance & Investments in Marcus & Millichap's Los Angeles office.

Supply of such capital is responding to the growing demand, he says. "There are more sources of equity and mezz financing today out there, compared to a year ago. Some are banks seeking to capture new business by lending off of their balance sheets, and some are non-regulated funds chasing yield that understand real estate."

These new sources of capital will also be increasingly tapped this year, he predicts, by CMBS property owners that have large amounts of equity 'held hostage' to defeasance costs. "Owners will see preferred equity and mezz financing as a way to take some cash out of their property and buy additional assets," Petriella says.

The cash-rich private lender is another new funding source he expects to see become more prevalent this year. "I have had clients say to me 'if you know of someone who needs to close fast or is having trouble finding hard money, send them to me.' These are people that don't want to enter the market directly because they don't know where it is going so they are willing to be short-term lender."

Chris Kelly, a managing director with CapitalSource, says that portfolio lenders will be the dominant source of capital for at least this year, and possibly into 2009. "We are going to see life companies, banks, and balance-sheet lenders like GE take the reigns from securitized lenders." Certainly portfolio lenders have been active during the past several months, but Kelly says the shift is more profound than many realize -- and it will become apparent this year.

2008 will also be the year that new buying opportunities emerge from the turmoil. Global markets are sure to continue to attract investors. Tom Shapiro, president, CIO and founder of GoldenTree InSite Partners in New York, for example, says that the firm is very active in Brazil right now, generating unlevered returns in the mid-20s right now. Historically, the company has maintained an investment portfolio divided 80%-20% between national and international markets, respectively. He expects that ratio to shift to 50%-50% for the long term. Short term? It will be 10%-90%, favoring the global markets, Shapiro says.

On the other end of the spectrum is the now-hot distressed debt market. It is well known that several funds have been raising capital to buy these loans. Indeed, Capital Source's Kelly says once these funds start buying debt, activity could jump-start the capital markets. "All this money is getting ready to be pumped into the market. Meanwhile, the investment banks won't be able to hold onto their mispriced debt any longer." The twain shall eventually meet, he says, "and that is when we will start to see our way back to some kind of normalcy." Q3 is when it will begin to happen, Kelly predicts.