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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2005

Hear the music of expanding orchestra funding

We enjoy the finer things in life, such as gourmet dining, luxury automobiles and the best seats in the house at favorite concerts and sporting events. Everyone likes to see the performance from a prime vantage point. This led to the development of orchestra funding.

You may be familiar with the concept of mezzanine funding. Traditionally, it refers to the second round of real-estate investments — the one dealing with assignment of the borrower’s ownership interests. But did you ever wonder why the term “mezzanine” is used? The mezzanine is the second section of a theater or stadium. Therefore, the orchestra, the first section, should be the proper term for the first round of real-estate funding. We don’t know about you, but we prefer orchestra seats.

Only a few patrons can sit in the orchestra. Great seats are hard to come by, and admission comes with a hefty price tag. The process is similar to entering on the ground floor of a real-estate deal. The big money often is made by investors who provide the seed capital for a project at its nascent stages. Getting in on a project in its early stages requires capital and usually a lot of it — the kind only wealthy individuals can muster.

In addition to requiring significant capital, investing in the orchestra stage of a deal is risky. Even large lending institutions are reluctant to bankroll a project until it is well into the second and third stages of development. These investments also take great expertise to know which deals are good and bad. A talented and experienced team that knows this business can pick the sweet deals from the bitter ones.

While lending developers orchestra funds can be quite profitable, it is only open to the wealthiest investors. To involve more investors and make more money available to developers, the number of orchestra seats needs to be expanded. This goal led to the concept of orchestra funds.

The best way to describe an orchestra fund is to think of a mutual fund. Orchestra funds operate much like a public mutual fund. Rather than investing in stocks or bonds, orchestra funds invest in the initial phases of real-estate ventures. Like mutual funds, behind orchestra funds are expert management professionals skilled in identifying real-estate deals most likely to maximize return-on-equity. Also like a mutual fund, orchestra funds provide diversity by spreading risk across various projects. If one deal fails to meet its profit goals, many more in the portfolio likely have exceeded profit expectations.

Investors will find these funds attractive for two reasons. Number one, they are just about the only way for investors to participate in the lending side of the real-estate business. Number two, orchestra funds can provide annualized returns of about 13 percent. For the borrowers, the cost will be the same as any seed-capital loan but will provide an alternative source of funding.

Until recently, the typical entry-level orchestra-fund investment was in the $500,000-minimum range. However, the price of an orchestra ticket has come down. It now is somewhere near $250,000. We hope that as orchestra lending becomes more popular, small, individual real-estate investors can participate in the orchestra phase for as little as $1,000.

In five to 10 years, orchestra funds could be a common component in the average investor’s portfolio. People who had never imagined they would put up money to build a harbor, commercial-office building or residential-housing community will be able to experience the pride and profit of creating something from virtually nothing. Average investors will have a vested interest in their world’s changing landscape and will experience what it’s like to view the performance from the orchestra.


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