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WASHINGTON, DC-At the Washington, DC RealShare Conference, held last week, keynote address speaker Edward Padilla, CEO of NorthMarq Capital, made a startling observation: CMBS’ attractive yields may well suck some of the capital out of the market. Heads in the audience nodded in agreement, and not too happily. Padilla had identified an emerging trend that is threatening the already scarce supply of liquidity for deals. “If you can purchase paper at 15%, why not do so, instead of taking on the origination risk,” said Sean O’Malley, regional director of RBC Capital Markets at RealShare.

It is not just CMBS that is luring away investors from active development. Bob Dougherty, a principal with Buchanan Street Partners, tells GlobeSt.com that the company is interested in buying whole loans at discounts, B pieces of existing loans and buying — as well as originating — mezz loans. “That is where we see tremendous opportunities,” he says. “We see returns starting at 15% and going to 20% on an IRR (internal rate of return) basis.”

He compares those numbers to JV equity deals – arguably the financial lifeblood of real estate development — which have a 150 basis point to 200 basis point higher spread, but with a lot more attendant risk. “We think risk-return ratio tilts significantly in favor of buying and investing in the illiquid loan space,” Dougherty says.

Life insurers – a key capital source now that CMBS has dried up – also show signs of abandoning equity transactions. Todd Everett, managing director and head of Real Estate Fixed Income for Principal Real Estate Investors, told GlobeSt.com in an earlier interview that the company is putting more investable cash flow into CMBS because it sees a good relative value. “We are finding products on the secondary markets that are available at yields that are very attractive. This year, for instance, we can acquire AA CMBS and junior AAA tranches at yields in excess of 9%.” (http://www.globest.com/news/1090_1090/hotseat/168354-1.html).

The prospect of less capital compared to what is available today is, clearly, a disturbing development. Companies that need to follow this trend most closely, say Dougherty and others, are those firms that are thinking about refinancing.

The choice is not pretty. A firm can refinance now – at higher rates. Or, it can wait for the second half of the year, when rates are likely to be lower, thanks to the incredibly fiscal and monetary stimulus packages that have been put together – but risk not being able to find a borrower because all of the available capital has been invested in the loan markets. “Frankly, we are telling our clients to grab the best deal that comes along right now,” O’Malley said.

Certainly, not every industry watcher thinks this is how the second half of the year will unfold. Bruce Baschuk, president and founding partner at J Street Development, correctly observed at RealShare that new equity sources are entering the market every day. “More equity is being dedicated to the real estate markets now, much of it still on the sidelines, waiting for the markets to settle.”

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