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Multifamily Bridge Loans, CRE CLOs and Pancake REMICs

• Dechert LLP • Episode 27

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What’s driving the robust and very competitive transitional multifamily real estate market? In this episode of 4 Real, hosts Jon Gaynor and Matt Armstrong highlight changes and emerging opportunities in this market with Russell Avery, Managing Director at Limekiln Real Estate Investment Management and Head of Capital Markets for their MF1 joint venture with Berkshire. The conversation explores the surge in construction-takeout and bridge-to-bridge loans, competitive dynamics between bank warehouses and CRE CLOs, as well as capital market trends like spread compression, term-out facilities at the end of a CLO life and repo financing. Plus, Dechert tax partner Will Cejudo breaks down Pancake REMICs, an innovative tax structuring tool poised to reshape deal execution across CRE finance. 

Show Notes 


Jon Gaynor:

Hello, and welcome back to the Dechert 4 Real podcast, where we discuss current issues and trends in commercial real estate finance. We aim to bring market commentary about developments, updates you can use, and maybe a little bit of banter along the way. I'm Jon Gaynor a partner based in Dechert's Philadelphia office.

Matt Armstrong:

And I'm Matt Armstrong, a partner based in Dechert's New York office.

Jon Gaynor:

In this episode, we are joined in our New York office by Russ Avery of MF1. We'll be talking with Russ about multifamily lending CRE CLOs, repurchase facilities and what's coming down the pike next year.

Matt Armstrong:

In our 411 segment, we'll talk to tax partner Will Cejudo about Pancake REMICs, a tax innovation that could be helpful in structuring a variety of deals. Watch out, CRE CLOs!

Jon Gaynor:

Mmm, delicious tax structuring. But first, let's get 4 Real with the hosts. Matt, for today's 4 Real, can you tell our audience what's a favorite movie of yours. Why?

Matt Armstrong:

So, I was thinking about this a bit on the train this morning, and I came up with the original "Point Break," not the new one that they did a couple years ago, but the original one. You've heard before on this podcast I'm a surfer, and so that movie really resonates with me. Keanu Reeves, Patrick Swayze, you really can't go wrong.

Jon Gaynor:

Oh, yeah. My wife had me watch that a few years ago. It still kind of holds up. It's great. For me, whenever, like, a comedy actor does, like, a serious movie, like "Stranger Than Fiction" with Will Ferrell is really, really good."Groundhog Day" with Bill Murray, "The Truman Show" with Jim Carrey. Like, I love those sorts of movies, but of those three, I think it's "Stranger Than Fiction."

Matt Armstrong:

It's a good one. Yeah, the other one I was alternating with is "Step Brothers" because for me, that is the most quotable movie. There are so many times in real life where you just come up with a quote from that movie and everything makes perfect sense. You know? "It's the Catalina wine mixer."

Jon Gaynor:

So good. All right. So that counts as getting 4 Real with the hosts. Today, in our 411 segment, we are joined by Will Cejudo, a partner based in our Washington, D.C. office. Will focuses his practice on tax matters relating to structured finance transactions, including distressed asset funds, mortgage securitizations and asset-backed securitizations. He's got extensive experience advising on the taxation of investment vehicles, including REITs and offshore funds, and critically, for today's conversation, REMICs. Will, welcome to the podcast.

Will Cejudo:

Thank you. Glad to be here.

Jon Gaynor:

So REMIC, for those of you who aren't in the know, stands for real estate mortgage investment conduit, and it's basically a vehicle by which you can pool mortgage loans and issue different classes of securities backed by those mortgage loans without suffering entity-level taxation. Otherwise, you have to find another structure or you end up in a taxable mortgage pool. So, REMICs are a big deal in the securitization world, and they're an important tool, especially in CMBS issuances. So, Will, we're really excited to talk to you about an innovative structure that you helped develop called the Pancake REMIC. To start, could you explain for our listeners the traditional limitations of REMICs regarding investment periods and what was the specific challenge you were trying to solve that led to this new approach?

Will Cejudo:

Sure, happy to do so. So REMICs, by statute, are allowed a pre-funding period of three months, and Congress seemed to have borrowed that three-month period from some IRS guidance with respect to fixed investment trusts. And so, the idea was the IRS wanted to give trusts some period of time to get all of their assets together. So, they basically gave them this three-month period. So when Congress got around to writing the REMIC statute, they seem to have just borrowed that three-month period and said REMICs you can buy in assets over this three-month period. So, the challenge became, when somebody in the RTL space residential transition loans, also known as fix-and-flip loans, had a structure, what they were trying to do was basically get the structure rated. They were trying to get a credit rating. And as you probably know, you can maximize your rating, typically, by paying your bond sequentially. And so, those RTL deals to date had all been debt for tax structures, so they had to avoid the taxable mortgage pool rules. So they had a very simple waterfall, very generally, all the principals paid pro rata. So the challenge became, how do we take a fix-and-flip deal and pay the bonds sequentially? And the only answer outside of a REIT, we couldn't go offshore. That was not a possibility. So the only thing really left was REMIC. And so, the challenge became, well, how do we take this REMIC with a three-month pre-funding period and turn it into something that is typical in the RTL space, which is a much longer reinvestment period. And in RTL space, these loans pay off relatively quickly. So in order to kind of justify the cost of the securitization, you need a longer reinvestment period. And so, I had done something in another structure where I had taken a look at this very similar issue. And the idea was, look, we oftentimes will make REMIC elections on the same day, right? So if we close a transaction, oftentimes you'll see a two-tier REMIC, and the IRS has blessed that structure. They've said even though these two REMICs were formed on the same day, pursuant to the same set of documents, we're going to recognize the separate existence of each of those two REMICs. So what you need to do is, how do we spread this out over time? So the answer is kind of in the REMIC statute itself, which says that at any time during the three-month period, what one REMIC can do is it basically can exchange its assets, its mortgage loans, for other assets. And so, what I did was just use that technology to say,"Well, look, we're going to set up one REMIC at the end of its three-month period. What it's going to do is it's going to exchange its assets, let's say mortgage loans and a pre-funding account, for regular interest in a newly formed REMIC." And what we would do is move the pre-funding account over to this newly formed REMIC. So what you end up with is REMIC 1 starts out on day one has three months. At the end of three months, it exchanges its qualified mortgages for regular interest in another REMIC. Those regular interests are, in turn, treated as qualified mortgages for the original REMIC. So you basically just get this swap of assets, and then that new REMIC, REMIC 2, then starts its three-month pre-funding period. So now we're up to six months, and then you can just see, we just keep doing this repetitively. In that deal, we did it for two years, and we've done that successfully in other transactions. And other folks out there, obviously, every time you do a transaction, there's someone on the other side. Other folks have picked up on the technology, and they borrowed it as well.

Matt Armstrong:

So these sound like sequential REMIC collections that are being made. Why is the name Pancake REMIC instead of Sequential REMIC?

Will Cejudo:

The naming was probably somewhat unfortunate. When I first explained this to someone, this person was like, maybe, maybe somewhat jokingly, just said, "Hey, you're just stacking these REMICs on top of each other, much like pancakes." And so, the name kind of stuck, and somebody else suggested Cascading REMIC, which I wish we would have picked up on. It sounds so much better, but I think we're stuck with Pancake REMIC, and so be it.

Jon Gaynor:

I think pancakes are delicious, so I'm OK with it. So this is becoming pretty standard in the RTL securitization market now, but it seems like it would have opportunities for expansion to kind of other asset classes and, you know, importantly for our audience, commercial real estate finance. How could the Pancake REMIC technology, the Cascading REMIC technology, apply to CRE CLOs and what would make it an attractive alternative to other structures, like the qualified REIT subsidiary structure that we see often in deals today?

Will Cejudo:

I think that anybody who's looking for a longer reinvestment period, anything beyond, you know, three months, you know, with a mortgage product, could certainly look at it. There's nothing about the Pancake REMIC structure in any way that's limited to RTLs or fix-and-flip loans or residential loans in general. So it can certainly be used for other products. And we've kind of thought about that a little bit. We definitely have CRE CLOs in mind as a comparison, just to see if there's some way to break down the barriers that have existed between those two structures. Typically, if people are looking for a longer reinvestment period, they've gone down the CRE CLO path. There are some limitations there, right? So, for example, you can't sell below investment grade in a CRE CLO structure. You know, REMICs, as we all know, you can sell, at least for tax purposes, all the way down the capital stack. So we'll see. There's, there's some potential there. I see folks may want to take another look at it. The big advantage, I think, then that CRE CLO would have over REMIC would be just the ability to do modifications. And so that's something we're thinking about, you know, is there some way in the Pancake REMIC structure to accommodate at least some of those modifications? Maybe not all of them, but at least some of them in such a way, again, that it's, you know, turns into a cost benefit analysis, and maybe someone looks at it and says,"Hey, this REMIC structure does have enough benefits. And yeah, I may give up some of my ability to make modifications, but so be it."

Matt Armstrong:

And so, what would the thought there be, Will? Would it be that during the reinvestment period, where we're having these sequential REMIC elections that are being made that during that period, any type of modification that could typically be made in a CRE CLO could be made on these loans? And then after the end of that reinvestment period, when there's no more REMIC elections being made, then modifications would be limited to what you would typically see in a REMIC deal?

Will Cejudo:

Yeah, and even during the reinvestment period, is still kind of looking at some of those modifications. You know, for example, just, you know, interest rate reduction to accommodate some borrower who was going to refinance somewhere else. That's the tough one. But other things like extensions or any kind of modification that arises because of a default or default that's reasonably foreseeable, we could still accommodate in a REMIC, but that's certainly it, Matt, is just trying to figure out, like, how can we accommodate as many of these types of modifications in a REMIC structure, again, to make it more competitive, I'll say, with a CRE CLO structure. But you're right. You're absolutely correct. Once that reinvestment period ends, then it's going to be much tougher to make any kind of mods. You know, I think at that point we really are back to just being stuck with our normal kind of REMIC mods, but during the pre-funding or reinvestment period, now, is there some way to do these types of modifications in a way and still kind of fit those into the REMIC structure? That's the challenge.

Matt Armstrong:

OK, I guess one other question for you here, Will, I guess an issuer that's structured right now as a REIT, what are the benefits to them to doing a securitization in a REMIC structure as opposed to in a qualified REIT subsidiary structure?

Will Cejudo:

Yeah, the big one that I see will be the ability to sell below investment grade bonds. REITs sponsoring REMIC transactions has always been kind of an issue, basically just because of one of the REIT rules, Congress didn't want REITs to be dealers in property, and so every time you issue a REMIC security, even though it's treated as debt, it's not treated as a borrowing undertaken by the REIT. A REMIC issuance of regular interest, it's treated as sale for tax purposes. And so that's that sale treatment that causes REITs to say, "Wait a minute. Am I going to be treated as a dealer? I've taken these loans, I've put them into this package, this thing we call a REMIC, that tranched up the cash flows, and now I'm going to go sell these regular interests." And so, that sale attracts 100% tax on any gain on that sale. And so REITs, typically, what they've done if they wanted to sponsor REMIC transaction is they run the assets through a taxable REIT subsidiary, which attracts income tax at a corporate rate, not 100% tax rate, at least. And then when you sell the regular interest, again, corporate-level tax, not 100% tax rate. And then some of those bonds can be sold up to the REIT parent. So there are definitely issues with a REIT sponsoring REMIC transactions. We've been trying to think of ways to minimize that tax hit and, again, do it in a way that does allow a REIT, ultimately, to get the benefit of below investment grade financing.

Matt Armstrong:

So this is something that would work really well for an issuer that's not set up as a REIT, but if they are a REIT, there would be some additional structuring that they'd have to do at the corporate level to use this.

Unknown:

That's exactly right, and we've seen it in the RTL space. Some of those sponsors are set up as REITs, so they've had to face this issue. Some of those sponsors are not set up as REITs, so they haven't had to deal with it. And we actually have one client where the ownership is split between a REIT and non-REIT, and so they've had to at least part of their ownership structures had to deal with the REIT issues.

Jon Gaynor:

Okay! Will, thank you for joining us today and talking to us so much about Pancake REMICs.

Will Cejudo:

Thank you. And there's definitely more to come. We are still thinking of ways to further implement the structure and ways for REITs to implement the structure in a way that, again, allows them to sell below investment grade, and do so in a way that minimizes any concern about prohibited transaction tax. So more to come.

Jon Gaynor:

Great. And if you want to read more about Pancake REMICs today, you can find a link to a recent article about the structure, which is authored by Will and counsel Daniel Ng in the show notes.

Matt Armstrong:

So, now on to our interview. Russ Avery is a managing director at Limekiln Real Estate Investment Management, but you most likely know them by their multifamily joint venture with Berkshire MF1, where he's head of capital markets, overseeing all things CRE CLO and repo for their platform, which has originated almost $27 billion of multifamily bridge loans since its inception in 2018. Before landing at MF1, Russ was head of CMBS structuring at Greystone, and before that, had tours of duty at Deutsche Bank and Deloitte. Russ, welcome to the 4 Real podcast.

Russ Avery:

Thanks for inviting me. This is great. I have to say, this is a bit weird. This is the first time I've ever been on a podcast before. I love the fact that your voices sound different when you're doing this, versus in normal life. So hopefully mine, mine's not too different.

Jon Gaynor:

I think between your accent and the quality and timbre you're well set up.

Russ Avery:

Excellent. Well, I think this is my destiny, because someone once told me I had a face for radio, so ...

Jon Gaynor:

I get that all the time. So, before we get into the substance, Russ, it's our tradition here to get 4 Real with the guests, too. So, do you have a favorite movie? Tell us about it.

Russ Avery:

First of all, I have to challenge you on "Point Break" and say, even though I do love the movie, it's only good because Keanu Reeves' acting is so bad.

Jon Gaynor:

Oh, totally, totally, yes, it's so bad it's kind of good in a way, like it's entertainingly bad.

Russ Avery:

But my favorite movie, I would say "Gladiator," I think. The original one. I'm embarrassed I haven't actually watched the sequel. I think I refused to watch the sequel, but it was at a certain point in my life where I just genuinely believed I was Russell Crowe. And I actually have a cat right now whose full name is Maximus Decimus Meridius, and when we take him to the vet, that's what they read out at the reception desk, seriously, so. Also anything with Arnie in it, and anything by Guy Ritchie.

Jon Gaynor:

All right, there you go.

Matt Armstrong:

Russ, MF1 is one of the largest lenders in the transitional multifamily real estate market. What is the current state of that market today? And are there any particular trends that you see developing?

Russ Avery:

Sure. So first of all, I'd say the market is robust. It's healthy. It's getting very competitive. It's definitely still lopsided towards refis - construction, takeout loans. I would say, in the last couple of years, that's probably been 85% to 90% of the loans we've been doing and putting in CLOs. If you compare that to 21-22, we were probably 75% acquisition and value-add financing. We love the pre-stay construction takeout deals, because from a debt perspective, they're generally below completion cost, like 75 LTV translates to 60% to 65% loan to cost. They're Class A shiny new buildings in great markets, very strong sponsorship versus the acquisition value add we were doing in the Sun Belt workforce housing a few years ago. So that's definitely been a theme. People have been talking about acquisitions coming back for the last year. It hasn't happened yet, but there are signs it's happening. I mean, I think roughly 40% of our pipeline at the moment is acquisitions, which is the highest it's been in the last two to three years for sure. Another theme we're seeing is stabilized, or near-stabilized deals, Bridge to bridge, where a borrower is wanting to borrow a balance sheet to float for a few years, basically delaying the sale they're able to park on a floater, roll rents, burn concessions, digest supply and just wait for a better day, which I think that better day is probably not too far away. Long-term rates tightening and LP equity investors finding stability. Also, there's still a pretty wide bid-ask spread in the acquisition market. That's something that I think needs to tighten before we see people comfortable taking on that term debt with more call protection. I think given everything going on in the world, even though you're not necessarily seeing realized volatility in the markets, there is massive option value in lack of call protection and just having that flexibility at the moment, I think that's been a huge tailwind for bridge loans. We're actually bidding and closing bridge loans that probably could be fixed-rate term loans, but borrowers just want that prepay flexibility.

Matt Armstrong:

When you talk about a large portion of your business coming from refis, it sounded like a lot of that is refinancing construction loans, but some, like you said, are refinancing bridge loans. So bridge to bridge.

Russ Avery:

Yeah.

Matt Armstrong:

How are bridge-to-bridge loans accepted in the market by rating agencies and investors?

Russ Avery:

I think rating agencies generally like them, because you have in-place cash flow. It depends. If it's bridge to bridge because the debt yield is really low, it depends on the story. Maybe someone's piling in a bunch of new equity, and you get comfortable with it that way, but most of the ones we're seeing, the debt yield is already at a stage that the rating agencies are comfortable with it. And it's funny, we have this argument all the time. Some people like the construction take-out pre-state stuff because it's Class A shiny new buildings. But you're going from a zero-debt yield to a seven-and-a-half, eight debt yield, which you could argue is there's more uncertainty there, even though, with correct underwriting, you kind of view that trajectory versus bridge to bridge, where you probably find where you are at the moment in terms of your debt yield, but there's less to do to get you to where you want to be, and you could almost be a term loan if you wanted to. Some people see bridge to bridge is a bad thing, because why are you not going to a term loan? But for me, it's just a timing thing. Like I said, they're waiting for a better time to lock themselves in for 5-10, years. At the moment, the optionality is way more valuable to people.

Matt Armstrong:

So right now is not a great time for borrowers to be locking themselves in for 10 years at the current interest rates.

Russ Avery:

I'm not necessarily going to take the view that it's not a good time, but not everyone thinks it's the right time.

Jon Gaynor:

So I'm sure you're looking well beyond the headlines of the recent interest rate cut by the Fed. I think a lot of people in the market who have loans originated in the 2022 vintage appreciate the slight relief. The markets digested that move. But what are you seeing in the longer term about interest rates right now? Are those longer-term expectations and shifts in the curve really shaping borrower behavior and loan origination, perhaps more than the cut itself, and maybe even future cuts that might be anticipated?

Russ Avery:

Yeah, so firstly, on rates, I think it's a very weird time at the moment, because with the government shutdown, there's kind of no data coming in to counter a 25 basis point cut at the end of this month. So I think that's pretty much baked. Inflation seems to be benign for now. The job data is getting weaker, and there's almost certainly another cut coming this year, and then I'm guessing two or more next year. The thing about rates, where they are at the moment, cutting rates, you're not applying the gas pedal, you're just lifting off the brakes. But back to the other question, how it's impacting origination at the moment, I'd say not really. We were kind of expecting more people want to do fixed rate this year. However, like I previously mentioned, the optionality, flexibility of just having no or less call protection on the bridge loans has been the major tailwind. And I think the major impact that rates are going to have is on the acquisition activity. I think more cuts should hopefully kickstart that, which I think is going to be a major change in theme in the loans that we're looking at.

Matt Armstrong:

And so right now you're looking at, what, one more cut in the short term? Do you foresee any more cuts after that? Or more of a wait-and-see approach?

Russ Avery:

October for sure, one more this year after that, and then my guess is at least two next year. But it depends on many things at the the kind of high political level.

Jon Gaynor:

Eventually, given just the nature of the board, and when people are going to roll off, we're going to get to a four to three dove situation, even if, like, you know, the courts don't force it sooner. So, you know, it occurs to me where there might be some logic in some people waiting on a fixed-rate execution if they think policy is going to change in a meaningful way in the near future.

Russ Avery:

You say waiting on a fixed-rate execution, though, if that goes to a four-three majority, and the Fed are cutting beyond where arguably they should, then that will steepen the curve, and I think the long end of the curve will sell off, and that could hurt you if you're waiting for a 10-year loan, because people are going to be anticipating an inflationary impact, which I think would be inevitable.

Jon Gaynor:

Never try to make an interest rate point to a bonds trader. This is, this is a mistake I make quite frequently.

Matt Armstrong:

Yeah. But does that mean that the the 10 year will go up in yield, or does that mean that just the short end of the curve is coming down?

Russ Avery:

I think probably both. You've got cuts obviously shaping the near end of the curve and the far end. I think the anticipation of an inflationary impact of those cuts beyond where arguably you should be cutting would would steepen the long end of the curve.

Matt Armstrong:

So with rates coming down or expected to come down with one to four more cuts, how do you see CRE CLO origination and volume next year?

Russ Avery:

First of all, acquisitions, like I said before, if they are kick started by rates will hopefully be closing more acquisition and value-add type loans like we were doing a few years ago, versus the pre-stake construction stake take-out stuff we've been doing recently, I think people will issue CLOs based on the loans that they're able to close, versus the cost of funds in the CRE CLO market, which I don't think is driven by rates as much as it's just driven by spreads. At the moment, bond spreads seem to be grinding tighter. They have been consistently for the last couple of years, and I think that will continue to happen, absent a macro event, which is obviously always possible. But there still seems to be consistent demand in bond investors. I felt like the the number of deals that are being called at the moment and money is being returned to bond investors in creating another supply-demand imbalance, which is hopefully going to help pricing for new issuance.

Jon Gaynor:

You just talked about bond spreads, potentially, you know, being narrow, staying narrow. I think part of the competition on cost of funds is the bank spreads that are being offered, and they're being very competitive relative to the capital markets right now, right? You're seeing the same thing, and like, a lot of attractive financings out there?

Russ Avery:

Yeah, I think one of the other themes from loans we've been looking at in last couple of years is we've been closing loans with absolute, like, blue-chip institutional sponsors that previously would have gone to a bank for that kind of financing, but the banks, given the capital treatment of closing a whole loan versus a higher attachment point on a warehouse repo facility, they would rather do that loan with us at the bottom than doing the whole loan themselves. So that has definitely been a theme which has driven borrowers towards the likes of us versus bank loans. But on the warehouse side, yeah, those spreads are inside the CLO cost of funds at the moment, at a lower advance rate and with other differences in structure, such as, like, mark-to-market recourse, not necessarily term matched versus CRE CLOs, but that has definitely driven competition for loans. There are people who we're competing with who have never issued a CRE CLO and I wouldn't necessarily expect them to, because they they get very good terms from banks.

Jon Gaynor:

And it's also going to depend a bit on where they are in the life of the fund, how comfortable recourse is for them to deal with that sort of things. Yeah. On the financing side, I think we've seen an expansion in the use of term-out repurchase facilities also as kind of a direct competitor to CRE CLOs, in a lot of cases, taking out CRE CLOs. How do you feel about that product and, like, what's interesting about it to you?

Russ Avery:

Yeah, so that's something that we're looking closely at the moment, given we have, I can't remember how many CLOs we have out the moment, I feel like it's 16. So it's something that I see is not necessarily competitive with CRE CLOs, I think for new, unseasoned loans, it could be given where spreads are on repo financing. We still prefer the CRE CLO execution at the moment, given the higher advance rate and the non-recourse, non-mark-to-market term match nature of it, which you get some of that technology with the term-out facilities, but not all of it, but it is certainly complementary. I think it is a very powerful tool for seasoned loans, where you don't necessarily get the same advance rate on CRE CLOs. It allows you to have flexibility to work out, modify loans with one counter party versus the bond investing world, and for that vintage of loans, you're less concerned about reinvestment and, like, replenishment optionality there, which is obviously part of CLO technology, and it's depending on where you are in your fund life, if you're kind of in that harvest mode of the fund life, having a term-out facility makes perfect sense.

Jon Gaynor:

Totally.

Matt Armstrong:

So you've mentioned that in these term-out facilities, it's much easier to modify loans and work with the borrowers. Is that one of the reasons that's leading to the prevalence of optional redemptions of CRE CLOs that we've been seeing in 2025?

Russ Avery:

I wouldn't say it's much easier to modify loans. I think one thing we've found with CRE CLOs is you have very defined boundaries to stay within, and obviously we work closely with yourselves to make sure we stay within those boundaries, but there is perhaps more flexibility to modify loans than we anticipated. But for sure, on a facility with one counter party where you can discuss more bespoke modifications, as you have a more adversely selected pool that definitely can help. But for me, the primary reason people have been calling CLOs is not related modifications. It's purely economics. Over time you're in a fully sequential structure where your advance rate is decreasing and your cost of funds is increasing as you get rate creep over time. At a certain point, it makes sense to pay the one-off cost of turning that into something else, whether it's another CRE CLO, which we've done. We call the deal on the day that it reached the end of its non-call period and put most of that collateral in another CRE CLO, or you can put it in vanilla warehouse, which comes with its own pros and cons, or you can put it in one of these term-out facilities, which is relatively new technology on the scale of things, but certainly is a powerful tool for seasoned loans versus leaving them in a CRE CLO.

Matt Armstrong:

So is there an incentive to call deals that were issued at times when spreads were high?

Russ Avery:

Certainly. Because what's the cost of funds on a new issuance today? 150-160 over versus the average 2022 CRE CLO was probably north of 300. So it would make sense to take that collateral and put it in a facility at a much lower cost of funds. Some of those 22 deals, because repayments have been slower, they're still at advanced rates north of 80%. So in order to call that and put it in an alternative, you're probably going to have to put cash in, whereas something from 2020-21, you're able to take cash out, get a higher advance rate and a lower cost of funds. And over time, you're going to get more cash out, because it's probably going to have some pro rata pay, then maybe a hybrid pro rata sequential, and eventually be fully sequential as you get more adverse selection, versus a CLO where you're fully sequential from day one.

Matt Armstrong:

So for these older deals that are not the 2022 vintage that had the higher spreads, at what point are you optionally redeeming those deals? Is it when the triple A's have paid down to zero, or about how much is left?

Russ Avery:

Yeah, I don't think you can define it by certain classes paying off. I think it's just an equation of advance and cost of funds prevailing in those CLOs versus what you could get away from that versus the cost of doing that, and this is more difficult to quantify, but the downside is you are going to be taking on some recourse and mark-to-market risk, certainly not as much as in the vanilla repo facility, but you have to weigh that against the better economics. A big part of my job is trying to time that and find the optimal time to make that trade, which, like I said, on our FL 12 transaction, was the day that it hit the end of its non-call period.

Jon Gaynor:

You were speaking about cost of funds and optimizing. And one thing that we've been looking at across asset classes recently is the so-called Pancake REMIC. Most CRE CLOs, as you know, are issued in a qualified REIT subsidiary structure. Part of that structure involves you taking down as issuer, a sponsor, all of the non-investment grade securities in order to use that tax structure. Pancake REMIC is different. It uses a REMIC tax structure, and that means you can sell below investment grade. There are other challenges being inside of a REMIC, such as, like, limitations on how you can modify loans, but there may be ways around that. The technology is developing. We wanted to kind of hear what your thoughts on this might be, and if, like, that's something that, like, the market should be thinking about, and how you weigh things like flexibility, about modifying loans against kind of better cost of funds.

Russ Avery:

From a high level, I think it would definitely be attractive to be able to sell below-investment-grade bonds, or at least repo them, which technically involves a sale, which is something that we can't do at the moment, which would allow you to maximize the return, get more leverage on those loans, if you're comfortable doing so. For that reason, I think it's probably more similar to a conventional CMBS-type REMIC structure than it is a CRE CLO and I'm guessing not just modifications would be different, but reinvestment would not be available.

Jon Gaynor:

No, the beauty of the Pancake REMIC structure is that during the reinvestment period, you would make sequential new REMIC elections. And thus ...

Russ Avery:

I understand, I understand, I appreciate it.

Jon Gaynor:

And it's a pancake, because you stack the REMIC elections on top of each other. We're also apparently workshopping Cascading REMIC. So you tell me if you've got a vote there, but the pancake is how you solve for the reinvestments. Yeah,

Russ Avery:

Because what I was going to say is it might suit the type of pool that you would do, a static CLO versus a managed CLO, because optionality would be less important. But obviously with the reinvestment that changes that answer. However, I think when it comes to modifications, what you generally see with static pools is their loans that are perhaps more close to being stabilized, and there's less volatility within there. It's more predictable, and you're comfortable with the duration that you're getting. And therefore, I think it would be a good alternative there, and it would allow you to get a higher advance rate, because, again, comparing it to a CMBS style REMIC structure, in a CRE CLO we

Matt Armstrong:

facilities? generally get the triple B minus credit enhancement level, which dictates the advance rate is anywhere from 11 to 13 these days. Compare that to CMBS, where it can be, like, five to seven. It's the advance rate is a lot higher and, therefore, being able to get closer to that by selling or repoing the double B's, for example, would be certainly something to consider, and could be a useful tool.

Russ Avery:

So, as I mentioned earlier, there continues to be strong appetite on the bond investor side, from money managers and insurance companies, especially. There's still a somewhat limited universe of supply, and I think spreads are going to remain tight and get tighter, absent a macro event and deals being called and continuing to give bond investors their money back is going to create an additional demand-supply imbalance there. On the repo side, new entrants to the market is something we're continuing to see - overseas banks, European, Japanese banks are increasingly competitive. Still, demand for the product from money center banks versus direct CRE lending, as I talked about earlier, with the capital treatment difference. But one thing I think definitely anticipating is more blurring of the lines between those two worlds, CRE CLOs and bank warehouse, which is, I think, neat that we've been discussing those two together. And I think that, like I said earlier, a couple of years ago, the term-out facility was not something that really existed. Now, it's something that is very relevant. And I feel like that's going to continue to evolve. People are going to innovate. There's going to be more efforts by market participants to come up with creative, flexible products for issuers to not necessarily compete with CLOs, but certainly complement them. Also, one other thing I'd add, I would love to see a fixed-rate CLO. It's something that we've been kicking around for a long time, and would love to be the first people to do it.

Jon Gaynor:

So this has been such a fun conversation. Is there anything else real estate-related that's on your mind you want to talk about?

Russ Avery:

So I feel like this is the point in a job interview where you say to me, like, "now it's your turn to ask the question." So I have a question for you, which is, I'd be fascinated to hear how you guys see the space evolving in the next year.

Jon Gaynor:

Wow, got us All right. So I don't have any stock answers to this. I am very focused on not just new entrants, but kind of like a broadening in kind of how banks are going to be lending to lenders like yourself. Over the next year, we think that banks are going to be more heavily investing in not only term-out facilities, but, like, note-on-note facilities, SASB alternatives, with folks where it is bank capital getting securitization capital treatment for them, but essentially financing more and different ways of loans. And, you know, there's an interesting push-pull, because some people complain that the buyers of CMBS, SASB, CRE CLOs even, it's too narrow, so they're looking for more ways to get some of those buyers more involved, maybe. And that's, like, just a huge focus that I think we're going to see a lot more of in the coming year, at least, on the kind of lending side, where I play more.

Russ Avery:

By buyers, you're referring to bond investors.

Jon Gaynor:

Bond investors. Yeah.

Russ Avery:

One thing that's been going on for a decent amount of time now is this transparency initiative that CREFC is spearheading, and I think they're doing a great job with CRE CLOs. I think that's very, very important to appeal to those crossover investors. One thing we're constantly talking about is, how do we get investors from the corporate CLO space? Because a lot of CMBS investors who look at CRE CLOs, they don't fully appreciate the CLO technology and the crossed equity between the CLOs and the power of being able to buy loans out versus a ring-fenced CMBS structure. On the flip side, you've got the corporate CLO investors who fully appreciate that, but don't understand the commercial real estate, and they find it opaque and difficult, which the lack of transparency has been one of those issues. As that gets better, that will help. And I think that's something we're looking forward to, is appealing to those crossover investors, which is hopefully going to drive our spreads tighter.

Matt Armstrong:

That would be great to bring in a new group of investors into this space. From my perspective, from what you said today, I'm hearing we're going to see continued spread tightening, absent some kind of a macro event. And I think if we continue to have spread tightening, we'll have more and more CRE CLOs issued over the next couple of years. It's great to see the development of these term-out facilities for the end of the life of the CRE CLO because it really provides a way, like you said, to call the deal when it no longer makes sense for the deal to be outstanding, and when you're getting a better advance rate or better terms on a term-out facility.

Jon Gaynor:

Well, awesome. Russ, thank you for joining us for this episode. It really was fun talking to you about this stuff.

Russ Avery:

My pleasure.

Jon Gaynor:

All right, and thank you to the audience for joining us for another episode of Dechert's 4 Real podcast. If you have any thoughts about this episode, or if you want to tell us which you prefer, Pancake REMIC or Cascading REMIC, share them with us at our email inbox, realpodcast@dechert.com. Also, if you like what you've heard, give us a five-star rating on whatever platform you found this on. This episode was hosted by Matt Armstrong and me, Jon Gaynor. Stewart McQueen, Sam Gilbert and Kate Mylod produced it. Production support is by Kara Ray, Mallory Gorham, Alyssa Norton, Peggy Heffner, James Wortman and Jacob Kimmel. Our editor is Andy Robbins of AudioFile Solutions. Thanks for listening, and we'll see you next time on the Dechert 4 Real podcast.

Matt Armstrong:

All right, it's dad joke time.

Jon Gaynor:

I got one. I really want to do it. I tested it earlier. So, I once submitted 10 puns to a joke competition. Yeah, I really thought with that many, one was sure to be a winner. But sadly, no pun-in-10 did. It's terrible. I know I love it.

Matt Armstrong:

That's pretty rough. I stuck with the theme today of Pancake REMICs and came up with a pancake-related dad joke. So why don't comedians tell jokes about pancakes?

Jon Gaynor:

Why?

Matt Armstrong:

Because they always fall flat.

Russ Avery:

Oh, dear.

Jon Gaynor:

Gosh. Russ, do you have one?

Russ Avery:

I do, and it is on the theme of today. Well, just real estate in general. Did you hear about the one vacant unit in the multifamily building?

Jon Gaynor:

No.

Russ Avery:

It was last but not leased. Apologies for that.