If you are an owner or potential owner of commercial property that needs financing up to 80-90% LTV, it is important to understand the available funding options so that you choose the best option for your project. Mezzanine and Equity Financing are two options that will be discussed in this article.
A mezzanine loan is subordinated to the first mortgage loan and comes in various forms and provides funding up to 85-90% of the required capital. The cost of this type of financing varies depending on the size of the capital structure, the type of asset that is financed, whether it is a stabilized asset or an asset that is either moved lower or developed higher. Mezzanine loans range from 10% for stabilized apartments or stabilized malls to filling stations to 18-20% for hotel and value added, housing rights conversion and development and higher for land. The various forms of the mezzanine include:
- Traditional Second Mortgage: This is secured by a second mortgage and is shieldable. In todays market, this type is rarely done, as most first mortgage loans do not want to handle a second mortgage loan during the foreclosure period.
- Other mortgage loans with no rights to explain: Usually, these are given to the seller of the property. They are paid out of available cash flow, but due to default they are not excluded. The result of the inability to shield gave rise to the traditional mezzanine loan.
- Traditional Mezzanine Loans: These are secured through assignments of the borrowers ownership. Due to the standardization, the lender discourages the borrowers ownership and becomes the borrower. An inter-credit and subordination agreement with the lending lender is necessary.
- Preferred Equity: Here, the lender becomes a direct partner in the ownership but has a desired return and if there is a capital even or even standard, the lender equity investor has a liquidity preference. The lender that the investor receives only the same desired return as if he were a mezzanine lender; he does not share in remaining profit, except that there may be a departure fee or other kicker if the lever is high.
- Equity Structured as Dept: Here, a stock investor wants the protection offered to a mezzanine investor, that is, collateral and security especially if it becomes a loan, better protection in bankruptcy. Even a stock investor can get better protection if there is environmental damage as a result of federal legislation in 1997.
The second financing option for those seeking high LTV funding for their commercial property is equity. Real capital comes in different forms. The most important feature of equity is that it shares in profit and does not have a guaranteed return which, if not paid, triggers a standard, resulting in loss of equity. It generally finances the risky part of the capital structure sometimes as much as 100% of capital requirements and generally seeks returns of more than 20%. It also has more control over the ownership and decision-making of owners.
- Typical Equity Structure: This is the ownership of the company, which has the title of the property. The investor has some control from the right to veto or approves all actions to the right to lead to any action. In general, the more money you invest in a project: a the greater the control you will have over the project, and b the better returns or promotes to the owner developer. Many investors today seek IRR-based returns. They seek the desired return usually 1-15% depending on asset class and how high the capital structure the investor is. However, other investors are looking for big hit and will only make offers where there is a decent chance of significant upside.
- Equity structured as debt: See above.
- Promote structure and waterfalls: Usually, institutional investors give capital and then, after achieving certain benchmarks, give the developer additional profit incentives that they call market. Marketing is kicking in after certain specified returns, ie according to the preferential rate, etc. For example, we can say that a project costs $ 10,000,000 and is expected to earn 15% on cost or $ 1,200,000,000 at completion and rent up: lets assume the developer can secure a construction loan of 75% of the cost or $ 7,500,000. The capital requirement is $ 2,500,000. The developer pays up 10% of the equity. Let us assume that the project is a project that will be sold at the completion. Lets suppose it takes years to build and it takes on the year to rent. Lets assume that there is a shopping mall and the anchor rents start at the completion and the lease agreements will enter the end of the second year. Let us further assume.