With traditional funds less available, brokers and their clients may find success with hedge funds

Milton Franklin, president and CEO, Nationwide Business Consultants of South Florida Inc.

As published in Scotsman Guide's Commercial Edition, January 2009.

Mortgage brokers and other industry professionals have been frustrated by the state of the commercial real estate finance industry for the past year. Everything has changed, and we are struggling to close the same deals that were easy to close less than two years ago.

There's been a shift: The money is still there, but it's in different places. Commercial banks have virtually evacuated the lending business. Asset-backed-lending hedge funds, on the other hand, are now prominent sources of commercial real estate financing. Mortgage brokers who understand the differences between hedge funds and banks can better help their clients find project funding in this difficult lending climate.

Hedge funds vs. banks

There are several operational differences between hedge funds and banks of which brokers should be aware. These include:

• Response time: Hedge funds' response time often is significantly faster than banks. They often can present term sheets within 72 hours and close within two or three weeks. Banks, on the other hand, may take as long as one month to review the transaction and another 30 days to close.
• Loan parameters: Banks typically are inflexible with a fixed set of parameters within which your clients' deals must fall. Hedge funds, on the other hand, typically are more willing to think outside the box. Their goal is to get the deal done rather than try to uncover reasons it shouldn't be done.
• Dealing with decisionmakers: The banking representatives with whom commercial borrowers typically work tend to be far-removed from the true decisionmaker on the loan application and rarely have direct involvement in the decision process. They simply compile the application information and aren't in a position to make suggestions that will guide your clients toward success. When dealing with hedge funds, on the other hand, you and your clients often will be able to communicate regularly with the decisionmakers.
• Cost: Hedge-fund transactions typically cost more than standard banking transactions. It is the nature of hedge funds that makes them costlier. They pool vast numbers of wealthy investors and often must return at least 10 percent to their investors. As such, there will usually be additional fees to cover expenses, and -- depending on the project size -- retainers. But they are providing a service that banks can no longer fulfill.

Project details

Asset-based hedge funds can be good sources of funding for multitenant residential projects, high-quality commercial developments with good cash flows or well-established business undertakings. Their preferred transaction amounts typically are in the tens of millions or even hundreds of millions of dollars. Quarter-of-a-billion-dollar deals are common, and multibillion-dollar deals do occur.

Asset-based hedge funds usually require borrowers to have at least 35-percent cash equity in their projects. In construction scenarios, they like to see 30-percent equity participation. If principals have less equity, hedge funds often require a joint-venture partnership with a source that can provide the additional equity.

For success with these firms, your clients also must have a well-devised exit strategy. A main objective for hedge funds is to understand how they will make a return on their investment and specifically how that will be accomplished. Vague and general verbiage in this area can result in a decision to pass on your project.

As you consider working with hedge funds in today's market, understand why they charge what they do and what fee you will collect. In some cases, multiple mortgage brokers will work on a single deal and will need to share those fees. Don't let this stop you from moving forward. Large hedge-fund deals can deliver huge paydays, something that banks have seemingly stopped doing altogether.

Milton Franklin is president and CEO of Nationwide Business Consultants of South Florida Inc. His company maintains relationships with nontraditional funding sources and offers a full range of creative-financing products and services to commercial clients. Nationwide also offers partnering opportunities to commercial mortgage brokers and overwhelmed funders. A graduate of Wharton Business School, Franklin is a business-financing consultant with 24 years' experience in financial services. Reach him at (786) 506-3578 or miltonfranklin@gmail.com for more information.