“Given this dislocation in the capital markets, we have found that preferred equity investments present a unique opportunity to generate outsized returns with an attractive risk-reward tradeoff, as they provide equity-like returns with debt-like risk."

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Meadow Partners recently completed five preferred equity transactions. Why are preferred equity investments attractive to Meadow in the current environment? What are you considering from a risk perspective in making these types of investments?

Generally speaking – and this is true to a different extent for all property types and locations – we are finding that the underlying market and operational fundamentals for real estate are strong. It's the capital markets that are currently experiencing issues.

Given this dislocation in the capital markets, we have found that preferred equity investments present a unique opportunity to generate outsized returns with an attractive risk-reward tradeoff, as they provide equity-like returns with debt-like risk.

As such, in the past four months we have invested more than $150 million in five preferred equity transactions through different Meadow Partners investment vehicles. The five investments include high-quality, fully leased, multifamily, office, and retail properties located in prime Manhattan and Waterfront Brooklyn neighborhoods – Williamsburg and Greenpoint.

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Previously, you have identified rescue capital and distressed investments as distinct opportunities with different return profiles. How would you characterize Meadow’s recent preferred equity investments?

In our view, the primary difference between rescue capital and distressed investments is the underlying property. In rescue capital transactions, the underlying property is fundamentally sound (which is the part we believe is most attractive), but the capital structure or ownership is distressed. When we talk about distressed investments, we are referring to a situation with both a distressed property as well as a distressed capital structure or ownership. True distressed investments have been much slower to play out, but we do expect them to materialize.

With this in mind, we would characterize our recent preferred equity investments as rescue capital (and two of them, more specifically, as gap financing).

The rescue capital transactions had an attractive senior loan in place that the owners wanted to retain. They had created significant additional value since the original senior loan was made, and they also needed capital for other properties. In a normal capital markets environment, the owners would have been able to refinance their senior loans and pull cash out – most likely at a lower blended cost of capital when factoring in the high interest rate on our preferred equity investment. In the current environment, however, preferred equity was their only option.

The gap financing transactions involved paying off an existing senior loan, replacing it with a new senior loan at lower proceeds and using our preferred equity investment to fill that gap between the old senior and the new senior (hence, the term gap financing).

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Why is Meadow Partners well suited to provide preferred equity?

Given our market knowledge and experience as both an owner and a lender, we are well positioned to provide creative and unique solutions, such as preferred equity, as we understand many of the transaction nuances much better than a traditional lender. In addition, we’re often already familiar with the properties and neighborhoods where we are evaluating an investment.

We strive to be a flexible and constructive partner because we understand firsthand that a deal process can evolve and real estate transactions rarely go exactly to plan.

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How are lenders getting creative in finding refinancing solutions right now? Are lenders working to identify solutions to extend loan terms?

We are not finding lenders to be particularly creative – our experience is that they’re generally being reactive.

Banks are demonstrating a real unwillingness to foreclose on properties, so they are continuing to give borrowers extensions on a de facto basis to try to come up with solutions.

Private debt funds, on the other hand, have generally been much more constructive in fixing problems. For example, in the gap financing preferred equity transactions, we worked with the senior lenders to craft a collateral package that was better for everyone.

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The current wall of rolling maturities is estimated to be nearly twice as large as after the global financial crisis. What does this mean for the commercial real estate debt market and have you seen anything similar historically?

I've given up on trying to predict what will happen in the future, but it's inevitable that the day of reckoning is coming. When banks kick the can down the road, maturities pile up, and eventually something has to give.

The closest parallel I’ve experienced was in the late 1980s/early 1990s – at the start of my career – when the largest provider of capital to the U.S. real estate market - the savings and loans industry - just disappeared. The S&L crisis caused a gaping hole in capital availability, and no one knew what would replace it. The current capital markets environment is reminiscent of that time to me. There is a great unknown now because the debt maturity numbers are so huge.

When we launched Meadow Partners immediately after the global financial crisis, we acquired a number of distressed investments – a distinctly different opportunity from the rescue capital preferred equity investments we are making today, but one that we expect to see later in the cycle.

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What is your long-term outlook for preferred equity investments?

The opportunity for the type of rescue capital preferred equity investments we are currently making is entirely a function of the turbulent capital markets environment and elevated interest rates. We view this as a point-in-time opportunity that will begin to dissipate when the Fed begins lowering rates. When interest rates are lower and the capital markets stabilize, the opportunity set will look very different.

For now, we are working on a robust pipeline of preferred equity investments in New York City and London. Some of these take a long period of time as owners negotiate with their senior lenders and others come together very quickly, but in all cases, we are bullish on these opportunities given the current environment.

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What is Meadow Partners’ experience making these types of investments historically?

Meadow has significant experience with preferred equity and mezzanine financings, having invested $575 million through 16 transactions since the firm’s inception. We were recently successfully repaid nine months prior to maturity on a mezzanine loan that we originated for a London multifamily property.