We get to talk to quite a few developers of commercial real estate (CRE) income-producing properties and virtually all of them want the same thing: co-investment equity financing that can be used to augment their own equity capital investment required to close escrow on the construction phase financing. Every CRE developer knows co-investment equity financing is a big stretch as the component issues of dilution, cost, timing, perceived investor loss risk due to execution risk management, and documentation requirements are big considerations. Peeling back the onion on this issue may prove to be helpful as co-investment financing has become something more worthy of consideration than ever before because it leads to acquisition investment financing opportunities that are so desirable right now in the capital markets.
Equity dilution is of course the biggest issue at the end of it all. A capital structure that recognizes the requirement for profit-taking to take place the day construction is complete would help reduce the impact co-investors would otherwise have on the long-term capital investment opportunity. While a large measure of the ADC profit opportunity will have to go to the investors there are transaction structures that can help make co-investment financing palatable.
Cost of Financing
The cost of the financing is always the issue that follows dilution. Costs of issuance are not going to be cheap and nobody is going to carry the costs to the closing table for the developer seeking to issue these securities. Be prepared to open your wallet in exchange for have a shot at the brass ring.
Timing of Co-Investment
Timing is the issue that developers go to bed with every night. They need that firm commitment going into the closing for construction phase operations. This requirement can have the impact of further extending the pre-construction period and thus increase the out-of-pocket costs the developer alone must fund. This is only manageable by creating a structure and plan going into the development deal at its onset (i.e.: conceptual stage risk management planning).
Co-investment lives or dies on risk management. This requirement not only applies to the nature of the market opportunity but also applies to the developer’s ability to demonstrate proactive execution risk management documentation. Reputation, experience and credit may not be enough in and of themselves. Comprehensive business operations planning, risk mitigation plans and related measures are a fundamental requirement to demonstrating “the water is safe for swimming”.
Due Diligence Documentation Requirements
The due diligence documentation is the key to kingdom. Co-investment equity requires demonstration of cost control and schedule control over the term of the investment (i.e.: that term being the construction period). This means all related ADC activities have to have third-party evidence that backs each and every material representation of fact. This trips up many developers as their documentation set is not sufficient or they have come to believe the opportunity is so good the lack of documentation will be overlooked. This will almost never happen. Find out whether or not you have a complete set of documentation.
The opportunity is there. Be The One…