Now more than ever commercial real estate (CRE) equity financing for the development of CRE income-producing properties is the key to the kingdom – and not for the reasons you might think. Setting aside the results of the election for the moment, the capital markets are responding hard to the economic recovery the country has entered. The amount of investment capital flowing into the market has included an incredible amount of capital investment in CRE properties in private placement offerings of equity securities in Direct Participation Program transactions. The demand has reached a crescendo for investment in acquisition financings and now we are running out of product. That’s where the equity financing for CRE development transactions becomes a real issue that requires a real solution but the developer has to do it in reverse order.
It starts with some form of a business-combination that isolates ownership from operating liabilities because a business-combination is designed to be a pass-thru entity. The Delaware Statutory Trust (DST) is extremely popular but don’t count out Widely Held Fixed Income Trusts (WHFITs), private Real Estate Investment Trusts (REITs) or Royalty Limited Partnerships (RLPs) from the possible avenues. The entity construct selected depends upon what the market will buy (DST constructs currently leading that charge in what we underwrite) and the ability of the CRE developer to create a credible due diligence presentation that is firmly anchored in third-party validation of every aspect of the proposed development.
The developer is frequently a co-sponsor with the other co-sponsor being one of the companies that has already created market acceptance with investment bankers (securities broker-dealers on the buy-side of the transaction) who can get a conditional commitment from the broker-dealer network to place the permanent equity side of the take-out financing for the construction lender. This is the first stage and requires the CRE developer to provide a comprehensive due diligence presentation (if you don’t know what is required please contact us for the typical requirements).
The second stage is the permanent mortgage financing take-out commitment and that is only possible if the first stage commitment is already there. The permanent mortgage financing take out commitment is not a big stretch with a boatload of firms participating in this market who want this business and compete hard to get it.
The third stage is the construction mortgage loan financing – the interim loan. The construction lender wants to know how they are getting out, and the first stage and second stage commitments provide that comfort but the commitment will only be an initial commitment until and unless the developer can demonstrate they can close the loan. That means the final stage has to happen pretty fast.
The final stage is the equity financing on a co-investment basis and that requires – once again – the participation of an investment banking firm (again, a buy-side broker-dealer) to agree to place the equity with an institutional investment entity on a short-term, large gain. The institutional investment opportunity has to be attractive and the end-to-end solution approach provides them with a near-term profit-taking opportunity and the option to participate in the long-term deal in some form if they desire.
This is where the market is moving and the king of the hill will be the one who embraces it.
Be The One…