Development and Recapitalization Projects
With pricing premiums to acquire certain properties in the Southeast at near record highs, the capital
markets have become more and more aggressive in placing capital in both new projects and existing assets.
Owners and developers today have more equity funding options than ever before, in the form of joint
venture equity, preferred equity and/or mezzanine debt, for new acquisitions, development of new or existing
projects, or to recapitalize existing properties.
To understand the recent increase in the availability of capital, one must look more closely at the forces
affecting the market and the demands and requirements that are being placed on capital sources investing
in real estate. Given the state of the investment market and the general positive returns on real estate
investments over the last few years, investors (i.e. institutional capital, wealthy individuals, hybrid lenders,
etc.) have directed more and more funding specifically targeted for commercial real estate transactions.
This surge in available investment capital has placed an even greater burden on those investors looking to
invest in new acquisitions that satisfy their yield and return requirements – something that seems to be more
and more difficult to achieve in today’s market due to the scarcity of value-priced product.
The result of this high demand and limited supply in the real estate markets has resulted in investors
becoming less aggressive in their returns and more creative in placing these dollars. Some investors have
looked beyond the traditional straight acquisition and now seek to joint venture with real estate sponsors to
either a) co-fund a new project acquisition or development, or b) provide funds for existing owners to
recapitalize their real estate assets, liquidate a portion of their equity or buy out a current partner.
Regardless of the scenario, these investors are participating in more transactions and, in the case where
these investors have no real estate management company, are not burdened by managing real estate
assets and look instead to the sponsor to provide those functions.
So what does this all mean to the real estate owner or developer? Additional leverage and liquidity.
Developers can now find additional equity or bridge/mezzanine debt to help spread risk, expand or increase
the leverage of a project. Sponsors looking to acquire an existing property can joint venture with an investor
and afford a larger asset. Owners who may have their properties encumbered by conduit debt (and may be
prevented from refinancing or taking on additional debt because of prepayment penalties or covenant
restrictions) may now have a means of cashing out a portion of their equity by bringing in a preferred equity
partner or mezzanine debt provider. The same principle can also allow a sponsor to cash out an existing
investor, limited partner or member without having to sell the property. In most cases, the sponsor would
maintain control of the property and continue to participate in all the management and leasing fees as the
managing member.
These capital sources have various equity and mezzanine structures at their disposal. These investors may
now provide as much as 100% of the required equity of a project (although 50% to 80% is more common)
through either a preferred equity or mezzanine debt structure, or a combination of both. In the case of a
preferred return structure, the investor owns up to a certain percentage of the asset and is allocated a
preferred return from existing cashflow and participates in the upside of the project. In some instances,
provisions for a sponsor promote can be structured, where the sponsor can increase his ownership share if
certain income or valuation targets are met.
With mezzanine debt, the investor provides a higher-interest loan (usually secured by the interest in the
partnership or corporation) to the sponsor, thus increasing the overall leverage over and above the first
mortgage. Mezzanine debt may or may not have a fixed rate and may have a back-end accrual or kicker to
the investor. The notable differences between the two structures are that a mezzanine structure permits the
sponsor to maintain complete control, typically caps the returns to the investor and has a more favorable tax
treatment.
Regardless of which option makes sense for the sponsor or developer, what is clear is the increased
availability of capital and certain capital sources’ desire to place this money. Perhaps it behooves
developers and owners to consider these alternatives while current market conditions prevail, so that they
may benefit from the liquidity and increased leverage that these programs provide.
About the Author:
Robert Hultslander is the Executive Vice President of Business Development for Impressa, LLC, (www.
impressagroup.com), a firm that specializes in equity and debt financing for acquisition, development and
recapitalization projects, with offices in Atlanta, Ft Lauderdale, Chicago and Boston.