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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2018

Emerge With An Alternative

Marketplace lending and crowdfunding create high-leverage financing options

Emerge With An Alternative

In the latter innings of this current economic cycle, as capitalization rates for acquisition deals are pushed down and, consequently, higher-leverage loans are in greater demand, prospective borrowers are increasingly exploring alternative sources of financing. The reason is simple: Traditional lenders aren’t able to provide the capital required to fund high-leverage, low-cap-rate loan requests.

Commercial mortgage brokers and borrowers, however, may have questions: What is alternative financing and what does it look like in the commercial real estate space? What reassurances are available to the cautious sponsor or investor who wonders if it is legitimate?

Alternative financing in the form of crowdfunding may be a trending topic, but it’s hardly new. Mozart used the idea in the 1780s to finance the composition of one of his early piano concertos, offering prospective backers copies of his manuscript in exchange for their financial support.

The first online crowdfunding event happened in 1997, when fans of British rock band Marillion raised $60,000 for the group’s U.S. tour. And music fans continued to drive the growth of online crowdfunding with the advent of ArtistShare, Indiegogo, Kickstarter and MicroVentures.

Why choose alternative financing? Because a lot of great deals may never get done without it. Many banks and other traditional lenders won’t finance transactions valued under $50 million because there’s simply not enough profit in it for them. And, because of the late stage of the current real estate cycle, many other lenders are feeling skittish or are simply tapped out. That leaves a big gap in the financing market — and a big opportunity for nontraditional sources of capital.

More than crowdfunding

All too often, marketplace-based alternative financing sources are lumped together with donation-based services under the catch-all of “crowdfunding.” This phrase is overly broad, often misunderstood and significantly understates the impact these innovations are having on the procurement of debt and equity capital for commercial real estate investments.

Debt-based crowdfunding was a logical evolution of Mozart’s model. With the arrival of this innovation, crowd-aggregated funds became more than just a donation being exchanged for perks. They could actually be an investment. Also known as crowdlending, peer-to-peer lending and marketplace lending, debt-based crowdfunding began in earnest in the early 2000s.

Why choose alternative financing? Because a lot of great deals may never get done without it.

In such a congested field, it can be difficult to tell the players apart. Some platforms accept funds only from accredited investors, but others take money from just about anyone. Some companies carefully underwrite each investment opportunity and others simply act as a matchmaker. To help commercial mortgage brokers and borrowers cut through the noise, here’s a brief taxonomy of alternative financing as it relates to online lending platforms.

Crowdfunding. Broadly defined, crowdfunding refers to the pooling of small amounts of investor- and donor-based capital to support a project. It includes everything from lending and equity investing to charitable donations via internet platforms. Need to raise money for Junior’s cross-country bike-a-thon? You’ve come to the right place.

Peer-to-peer (P2P) lending. P2P lending is similar to crowdfunding, except the lender is repaid. P2P refers to the pooling of capital from individual investors (retail or accredited) who essentially provide small personal loans via internet platforms. This type of financing is perfect if you are trying to procure business capital to start an online jewelry business or recapitalize a child care center.

Marketplace lending. It is similar to P2P, but loan sizes are larger and more institutional in character. The term was coined to describe internet platforms through which accredited or institutional investors provide business loans, including mortgage debt, to sponsors. If P2P is your aunt’s investment club, then marketplace lending is your cousin’s commercial real estate business that is renovating a multifamily apartment complex in Akron, Ohio.

Curators and matchmakers. Within marketplace lending, there is an important distinction between platforms that list all investment opportunities and those that curate. Some curators even assume a more direct approach by carefully underwriting transactions, structuring the capital stack and mentoring operators through the investment’s life cycle. If matchmakers are like flea markets, then curators are like art galleries, with each company bearing unique sensibilities and reputations when evaluating a project.

Post-recession growth

Although many online lenders were established prior to the Great Recession, none really thrived until afterward. In 2008, bank retrenchment created significant unmet demand for loans, and that was the invitation that purveyors of alternative financing needed.

Even borrowers who qualified for funds from conventional lending sources often found that peer-to-peer lenders offered better interest rates. Real estate lending was so sharply curtailed by banks that, in many instances, alternative financing sources were the only available option. By the same token, low interest rates opened many eyes to new investment opportunities, including the idea of lending their money to strangers via the internet.

Bank retrenchment created significant unmet demand for loans, and that was the invitation that purveyors of alternative financing needed.

Things didn’t really heat up for online funding of commercial real estate debt and equity until 2016. That’s when Title III of the JOBS (Jumpstart Our Business Startups) Act came into effect, allowing nonaccredited investors to directly place money into private businesses through regulated funding portals or broker-dealers. The result has been a proliferation of crowdlending sites offering everything from fix-and-flip lending to straight commercial financing opportunities.

Late-cycle innovation

When it comes to an investor’s money, a commercial mortgage broker can’t be too careful, so it’s natural to wonder about the legitimacy of these new financing processes and instruments. Who regulates alternative financing?

Many alternative funding sources that offer securities are regulated by the Securities and Exchange Commission (SEC) and, if they operate under a broker-dealer license, they are regulated by the Financial Industry Regulatory Authority (FINRA). Like banks, alternative lenders are government-regulated entities, but the regulations pertaining to these lenders are often considerably less stringent and allow for greater flexibility. After 10 years of increasingly successful integration with the commercial real estate market, it seems likely that alternative lending is here to stay.

At the far end of the current economic cycle, online lenders are once again meeting unmet demand for capital. Even though superheated competition among private lenders has driven down bridge-loan interest rates, opportunistic investors recognize that this economic cycle may soon come to an end. They are now curtailing leverage in anticipation of the inevitable market correction.

A novel approach to addressing the leverage gap comes in the form of subordinated financing designed to follow behind third-party senior lenders. This may come in the form of a gap-financing program. In this example, a sponsor that meets a lender’s rigorous underwriting standards can qualify for second-lien debt for projects that may already have senior financing identified, provided that the two lenders can reach an acceptable intercreditor agreement.

For sponsors and investors, this can mean higher leverage (up to an 85 percent loan-to-cost ratio), a faster closing period and greater access to fully underwritten financing opportunities. Keep in mind that gap financing has risks, so mortgage brokers should make sure to do their due diligence.

•  •  •

You may have gathered that the alternative-financing industry is awaiting its Shakespeare. It is badly in need of language to differentiate the various types of crowdlending. There is no catchy term to describe how it applies to real estate, for example. Similarly, there is no term to indicate whether a given platform caters to accredited or nonaccredited investors, whether its investment opportunities are curated or not, or whether it will guarantee closing by lending from its own balance sheet or through securitization. 


 
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  1. Posted: Jun 28, 2018  3:26 ET
    By: Becky Ford | Becky Ford Int.
    1. 0


Hello,

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info@fordcreditcentre.com

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www.fordcreditcentre.com


 

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