The Brentwood-based business went from making $500 million in loans annually before the crisis to more than $4 billion last year, according to the company.
Now, having survived one major recession and seen long-term growth in its wake, Mesa West founders Jeff Friedman and Mark Zytko believe the aftermath of Covid-19 could create similar opportunities in their space.
“We are already seeing (lending) opportunities that wouldn’t have been there in January,” Friedman said. “In this type of environment, we can lend at lower leverage with better covenants and charge more.”
The company’s track record, along with its ability to capitalize on unique situations, were among the reasons Mesa West was acquired by Morgan Stanley in 2018.
“From our perspective, we had grown from an independent boutique firm to a firm competing with other large international financial institutions,” Friedman said. “We felt like having a major player backing us made sense.”
Seeking flexibility
Mesa West, which Friedman and Zytko said was one of the first nonbank institutions to focus on packaging commercial real estate debt for an institutional investor audience, got its start in 2004.
That’s when former Credit Suisse Group colleagues Friedman and Zytko decided they wanted to find a more flexible way to deal in real estate debt than commercial mortgage backed securities.
Such securities, known as CMBS’s, are large bundles of commercial real estate debt packaged together and sold to investors as bonds. They make real estate debt investments more liquid and can provide some degree of diversification to holders owing to the potential range of property types backing the security.
They are also, however, somewhat limiting in the types of debt that can be incorporated.
“The key for the CMBS market is to make everything the same. It’s making widgets to package everything together,” Friedman said. “That helps buyers to understand what they are buying, but it limits your ability to tailor to special situations with your borrowers.”
Friedman said he and Zytko bet that they could find better investment opportunities for institutional investors like pension funds and insurance companies if they broke away from the CMBS structure.
“We are really in a service business,” Friedman said. “We specialize in making a loan that is customized for a particular transaction.”
Added Zytko, “That model existed for banks and life insurance companies, but pension funds — corporate and public — tend to have a very small staff. … Providing the opportunity to invest in private real estate debt to that type of investor was unique.”
When Mesa West was first established, Friedman said the two partners had to rely heavily on established personal relationships to gain traction.
They soon, however, began to prove themselves to both real estate borrowers and institutional investors alike through their measured, hands-on approach.
“When I was first interviewing and getting to know Jeff Friedman, I noticed that he had five backup cellphone batteries,” said Edward Schwartz, principal and co-founder at ORG Portfolio Management. “I thought, ‘Wow, this guy must be careful, always thinking about the possible downside.’”
Schwartz serves as an investment adviser to a range of large pension funds. He has worked with Mesa West since its founding and said the company set itself apart early on for its focus on safe, reliable returns.
“They are very focused on income,” Schwartz said. “When you make investments with them, they are very careful to protect on the downside. … For pension funds that’s what we look for.”
Stress testing
Mesa West’s conservative approach paid off when the 2008 financial crisis hit. While more aggressive lenders watched their portfolios collapse alongside the broader real estate markets, Mesa West was able to weather the recession from a position of relative strength.
“I think we made good choices ahead of that,” Zytko said. “It took some discipline and not doing every deal that we wanted to do, but we ended up better positioned (as a result).”
Zytko said Mesa West never missed a payment to its investors throughout the financial crisis. In addition to avoiding less risky borrowers, the company’s focus on debt rather than equity helped hedge against the worst of the downturn.
“Even though borrowers’ (real estate equity) value dropped, the value of the loans stayed the same,” Zytko said. “When (property) values go down, the commercial real estate debt portfolio still pays interest.”
“A light went on for some investors who said, ‘Wow, this is a really valuable piece of my portfolio,’” Zytko added.
In the decade following the financial crisis, nonbank lenders of all stripes took a more central role in the U.S. finance ecosystem. With major banks operating under tighter regulations, new lenders stepped up to provide more complex, smaller or riskier loans.
Mesa West thrived in this environment, with annual loan volume growing roughly eightfold over the decade.
“Going into the financial crisis, we were only operating in L.A. because we thought that was where we had a relative advantage,” Friedman said. “Following it, we took advantage not just by increasing our loan originations but by increasing our market footprint.”
Over that period, Mesa West grew from a regional lender to a major national player in the real estate debt space. The company opened offices in Chicago, New York and San Francisco, eventually drawing the attention of some of the largest finance titans in the world.
“That really led to the interest in Morgan Stanley in acquiring us,” Friedman said. “They wanted to provide their investors exposure to real estate credit.”
The investment banking giant bought Mesa West in early 2018, incorporating it under the umbrella of its asset management division. According to Friedman, his company’s core investing business is still run largely independent of Morgan Stanley with only back-office functions integrated following the acquisition.
Time to shine
Morgan Stanley’s backing has been especially helpful since the onset of the Covid-19 crisis, according to Friedman.
“They’ve helped us make sure we are connected for remote work,” he said. “If employees are looking for counseling, they provide that. They’ll also help us with physical changes to our environment when that’s needed.”
Despite the common difficulties encountered by any business under the pandemic, the effects on Mesa West’s portfolio has been limited, according to the founders. That was due in part, Zytko said, to the company’s typical conservative approach.
“We were very underweight (in) hotel and retail,” Zytko said. “We had already decided that those properties were more volatile in their performance.”
Less than 5% of the company’s total real estate debt portfolio is in hospitality and retail, according to Zytko.
Similar to the financial crisis, the current down market is also helping highlight Mesa West’s value to its investors.
“While they might have underperformed some of the high-flyers at the top of the market, now is the time where you appreciate them and their portfolio,” said ORG’s Schwartz. “Right now is when they are going to shine.”
