* Mezzanine refinancing established as 'new form' of equity
* Funding gap on UK property seen at $54 bln in 2011-13
* Mezzanine funds chase refinancing returns of 8-15 percent
By Andrew Macdonald and Nia Williams
LONDON, Dec 10 (Reuters) - Specialist debt funds are poised to pour cash into the multi-billion pound UK property funding hole left by retreating senior lenders and tumbling prices, nabbing hefty returns and a side-door stake in the sector.
"Mezzanine (debt) provides investors with the opportunity to get exposure to those types of properties they like, without having to buy them," said Andrew Radkiewicz, managing director of Pramerica Real Estate Investors.
The trend uses mezzanine funds -- traditionally a short-term high-interest bearing bridging loan -- to fill a longer term funding gap. The debt will be subordinated by holders and may have some call on the asset itself through prearranged deals with the remaining senior creditors.
This new type of funding will usually fill the gap between the first 60 percent of value in the asset, covered by senior debt, and the final 20 percent, covered by equity. This gap is known as the 60-80 percent loan-to-value (LTV) band.
Property consultant DTZ estimates there is a $12 billion 60-80 percent LTV opportunity in 2011, growing to $18 billion in 2012 and $24 billion in 2013.
This new type of funding is already happening -- U.S.-based Beacon Capital Partners' 200 million pounds ($317 million) o ongoing refinancing of its Mid City Place offices in London includes about 50 million pounds of mezzanine.
Separately, more than 1 billion pounds of mezzanine refinancing over five deals on prime London property are up for grabs in first-quarter 2011, industry sources said.
"It's taken a while for real estate investing institutions to identify this (refinancing opportunity) as falling within their umbrella of being a real estate investment," Radkiewicz said, noting these include institutional investors, sovereign wealth funds, pension plans and hedge funds.
Already several mezzanine funds -- Pramerica, Duet Capital and LaSalle Investment Management -- have taken commitments totalling several hundred million pounds, with material hikes in inflows predicted for 2011 and 2012. Now, others funds are trying to catch some of the action.
Dale Lattanzio, chief investment officer of Duet Group's European Real Estate Debt Fund, noted a strong desire among property investors to use mezzanine beyond its more traditional role of helping fund big-ticket direct investments.
"We've seen some property investors using that to get exposure to strategic assets," Lattanzio said, referring to prime assets that needed refinancing but were not for sale.
On average, fund managers expect returns of 8-10 percent for prime-grade assets, and up to 15 percent in some cases.
Returns on mezzanine refinancing of selected secondary properties -- those on and beyond the periphery of blue-chip business hubs -- is seen starting at 12-15 percent, reflecting the cost of higher risk.
"The total returns depends on where you sit on the risk profile ... but mezzanine is still cheaper than a lot of equity at the moment," said Phil Cropper, an executive director at property consultancy CB Richard Ellis.
RISK BECOMES LIQUIDITY
Radkiewicz said the market is starting to treat mezzanine as less than high risk because many of the funds providing it are using pure equity, rather than leverage, and are keeping the deals on their balance sheets without syndication.
As a result, the new funding neither disturbs nor dilutes existing equity. "It's really about the provision of new forms of capital into deals," said one fund manager.
Mezzanine ranks below senior debt, and before a refinancing deal goes ahead, the two providers agree what actions a mezzanine provider can take -- including injecting capital and becoming an equity holder -- in the event of a defaults or breach its covenants.
Mezzanine debt will continue to be used in its traditional role of direct investment in prime property, but a shortage of stock coming to market means that role will be limited, even though many blue-chip investors have built up capital to buy discounted assets.
"If you take that wall of capital and try and put it into buildings that aren't for sale, it's not going to happen. That's where two-thirds to three-quarters of our business will be, this wall of capital just can't do these deals," Radkiewicz said.
The new role for mezzanine, along with low interest rates, means owners of prime property are already seeking to refinance debt due in 2011 and 2012 and tie in good terms while they exist, said Rick Gambetta, of Matrix Property Fund Management.
"The days of waiting until the week before getting a loan are gone," Gambetta said, noting Matrix would provide junior and bespoke mezzanine debt via its ungeared mortgage fund.
"Mezzanine and junior funds are in a nascent market and to jump in straight away to the secondary (property) market would be very brave," Gambetta said. (See www.reutersrealestate.com for the global service for real estate professionals from Reuters)
(Editing by Andrew Callus) ($1=.6313 Pound)