I have been requested to help raise about $5.5 million in venture equity for a multifamily development project. This endeavor will give us a good example of structured finance. Structured finance in commercial real estate finance consists of (1) mezzanine financing; (2) preferred equity; or (3) venture equity.
A construction mezzanine loan is merely a mezzanine loan that is junior to a construction loan and which takes the capital stack from about 60% to 65% loan-to-cost up to around 75% to 80% loan-to-cost. Since the principals on my multifamily development project can only contribute about 10% of the total cost of the project, they are unlikely to qualify for a construction mezzanine loan. Remember, my developers need a lender or an investor to take the capital stack up to 90% of cost.
Preferred equity is a little more sophisticated than mezzanine financing, and it is usually used when the first mortgage loan documents say, "Don't you dare put a mezzanine loan behind our first mortgage; otherwise, we'll accelerate your loan (declare the whole loan due and payable), hit you with a defeasance prepayment penalty equal to about 23% of the loan amount - ouch, and then also unleash a springing personal guarantee, making our formerly non-recourse loan (the debtor can just walk away) into a recourse loan (if you try to walk away, we'll cut off precious body parts). I'll blog more on preferred equity later this month.
While preferred equity investors (its not really a loan) do have a little more appetite for risk, they are still unlikely to invest higher than 80% in the capital stack. Preferred equity will therefore not solve my developers' problem. My clients simply don't have enough equity (skin) in their development deal.
Okay, the third type of structured financing is venture equity. Venture equity is slightly different than a joint venture partnership. A joint venture partnership normally comes from some huge financial institution, a company like Met Life or All State Life. The life company puts up 100% of the total cost of the project in return for a preferred return (they get paid first) of, say, 7%, plus 50% of the profits. Joint venture partnerships are typically B.I.G. projects - think office towers or regional malls which cost $75 million or more to develop.
Here is a rule about joint ventures that will serve you well. If your developer couldn't fund the entire $75 million project out of his own pockets, he will never qualify for a joint venture. Huh?Remember that old saying about banks only being willing lend to you money when you don't need it? Well, the really huge lenders will only joint venture with a developer who is rich enough to fund the whole project himself. Mortals like you and I will never feed our families by closing a joint venture deal.
Venture equity, on the other hand, comes from smaller institutions, such as hedge funds (the sponsor publicly advertises for accredited investors), opportunity funds (a bunch of filthy rich guys throw some money in a pot), or REIT's. Venture equity deals are much smaller, typically $10 million to $40 million. Venture equity does NOT cover 100% of the total cost! Venture equity typically only covers 70% to 90% of the total equity required by the construction lender. The developer has to contribute the rest.
Venture equity is also very expensive. Venture equity investors typically expect returns north of 20%. Most venture equity firms were crushed during the Great Recession; but greed has finally brought them out of their shells. It is once again possible to find venture equity.
Do you need a mezzanine loan?
Do you need a permanent loan, a construction loan, or an SBA loan? Fill out one short mini-app and then submit it to 750 commercial lenders. And C-Loans.com is free!
Keep your eyes and ears open for bankers making commercial real estate loans. We'll trade you the contents of one banker's business card for a free directory of 2,000 commercial real estate lenders.
Do you need a commercial lender who will actually lend up to 75% LTV? Do you need a lender who will also look at the borrower's global income - income from salaries, other investments, etc.? Do you need a lender who will allow the seller to carry back a second mortgage? Does your client have a balloon payment coming due on his commercial property? Has your bank offered him a discounted pay-off? Does your borrower have less-than-stellar credit? Is your client's company losing money? Is your borrower a foreign national? Do you need a non-recourse loan? Do you need a commercial loan with no prepayment penalty? Is your client's commercial property partially vacant? Do all of your commercial leases run out in the next 18 months? Do you need a lender who will allow a negative cash flow?
Have you checked out CommercialMortgage.com yet? It is far simpler than C-Loans.com, and it enjoys four times more lenders.
Need a business loan not secured by real estate?
You can buy the complete Blackburne List of 2,000 Commercial Lenders for just $39.95.
Mortgage brokers, how many huge loan fees have you lost because the borrower cheated you or lied to you? As my dad used to say about horseback riding, "If you ain't been thrown, you haven't ridden' very much."
I am always looking for subjects upon which to blog. Got a commercial real estate finance question?
You've seen how I teach. I try to use very plain English and lots of examples. (Today's lesson was admittedly pretty sophisticated.) It's time to learn your profession.
Get free training in commercial real estate finance. I started out writing these training articles to teach my fine two sons the profession of commercial real estate finance. I had some health problems at the time, and I was afraid I was going to croak. Fortunately the doctors fixed me; but these blog articles ended up being a great way to meet fellow professionals in this industry.
Got a friend or co-worker who would benefit from learning commercial real estate finance (CREF)?