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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2008

How Private Equity Fits Your Deals

Help borrowers decide whether to use senior-debt or mezzanine-debt financing

With credit markets tightening, many developers and investors are being forced to the sidelines as the big banks run for cover. In this environment, private equity provides a way to turn deals around quickly and to avoid losing deals under contract. It also allows your borrowers to spread limited resources over a wider range of projects and promote portfolio growth.

Private equity has become a jewel in the commercial mortgage industry crown. Many people, however, don’t know whether their deal will be a good fit for this sector. When it comes to private equity, you should understand specifically what type of financing to go after.

Many people confuse private equity with hard money. Hard money is typically “hard” debt -- meaning that for a lower loan to value (LTV), higher interest rate or both, the lenders will close the loan.

Private equity, on the other hand, will generally require project partnership, with a rate of return based on the equity invested. Two common forms of private equity are senior-debt and mezzanine-debt financing.

Depending on the type and structure of the deal, a senior-debt-provider may fund 50 percent to 75 percent of the total project. In a traditional deal where owners bring plenty of cash -- perhaps through a 1031 exchange -- senior-debt financing may be the answer. These loans usually require full documentation.

A mezzanine loan, meanwhile, is subordinate to a property’s first mortgage debt but senior to the equity invested by the borrower. These loans have debt and equity characteristics. They offer a fixed or floating interest rate that is paid currently by the borrower. They have collateral in the form of assignments of partnership interest or other subordinate collateral. They receive equity participation in the cash-flow streams or residual value of the projects.

In our current market, mezzanine financing may be hard to find. If obtained, however, it can present real value.

LTV and loan to cost will vary among lenders depending on the strength of the deal. That said, if you’re working on an acquisition or development transaction, your clients will generally need the following:

  • A site plan and physical description of the property
  • Aerial photo, if available
  • Development-cost breakdown
  • Development schedule, including pre-development, government approvals, construction and lease-up projections
  • Market analysis, including comparable sales and rents in the area
  • Land-use analysis
  • Pro forma and exit-cap projections
  • Leases and lease abstracts, if available
  • Environmental study and geotechnical soil analysis, if available
  • Title report and survey, if available
  • Rendering and concept plans, if available

For acquisition transactions, borrowers should also be prepared to provide:

  • Asking-price information;
  • Three-year historical operating statements, including occupancy figures;
  • Interim operating statements;
  • Rent roll; and
  • Terms of existing debt, including assumability.

Most private-equity investors will review a project without all this documentation upfront. Brokers should inquire to see what they’d prefer. 


 


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