From Hasegawa

From Hasegawa

Mezzanine or Equity Financing - Which is the best choice for you?

If you are an owner or prospective owner of commercial property in need funding of up to 80-90% LTV, it is important to understand the financing options available to you, for you to choose the best option for your project. Mezzanine and equity financing are two options discussed in this article.

A Mezzanine loan is subordinate to the first mortgage and comes in many forms and provides financing up to 85-90% of the capital required. The cost of such financing fluctuates based on the top of the capital structure of the funding is granted, what kind of assets financed, if it is a stabilized asset or an asset that is well repositioned (lower) or developed (top). Mezzanine Loans extended 10% for dwellings stabilized or stabilized in the malls filled to 18-20% for hotels and value-added plays, condo conversions and development, and more for the land. The various forms of mezzanine include:

1. Traditional Second Mortgage: This is secured by a second mortgage and is Foreclosed. In today's market of this type is rarely done because most of the mortgagees do not first want to deal with a mortgagee in the second, including the implementation mortgage.

2. Second mortgage with no rights to exclude: This is usually given to the seller of real property. They are paid from available cash flow, but in the pair of default, there is Foreclosed. The result of the inability to exclude resulted traditional mezzanine lending.

3. Conventional Loans Mezzanine: These are secured by assignment of the ownership interest of the borrower. In the couple of default, the lender excludes the debtor's property, and becomes the borrower. Intercreditor and subordination agreement with the lender than necessary.

4. Preferred Equity: Here, the lender becomes in a direct partner in the property, but has preferred a return and if there is even a capital or even of default, the lender (investor in the capital) has a liquidation preference. The lender investor only gets the same return on preference like a mezzanine lender, no residual profit sharing, except that it could be an exit fee or other "kicker" if the leverage is high.

5. Equity as Department: Here an investor wants protection offered to a mezzanine investor, ie the guarantee and assurance (especially if you get a mortgage), better protection of bankruptcy. Also an investor can get better protection if there are environmental liabilities as a result of federal legislation in 1997.

The option of other forms of financing for those looking for high LTV financing for your commercial property is equity. True equity comes in several forms. The most important feature about the fairness is that the shares in profits and not have a "guaranteed return" which if not paid causes a defect, with a resulting loss of equity. Usually, the finances of the most dangerous part of the capital structure (sometimes up to 100% of capital requirements and generally is the search for yields above 20%. It also has more control over operations and decisions of the entity owned. Several forms are:

1. Typical Equity Structure: The is the property of the entity that has title. The investor has a certain amount of control of the veto or approval of all actions for the right to cause the actions. In general, the more money you invest in a project: (a) the more control you have over the project, and (b) the profitability or promote the owner / Developer. Many investors today are looking for returns based TIR. It generally prefers a search for yield in the range of 1-15% depending on asset class and how at the top of the investor's capital structure leaves. However, other successful investors look for "large" and will only do deals where there a decent chance to rise significantly.

2. Equity and debt: see above.

3. Structure and promote the Waterfall: In general, Institutional investors provide capital and then, after reaching certain milestones, incentives give additional benefit to the developer that they call the "Promotion". Promote kick after some specified performances, ie after the return of preference, etc. For example let's say a $ 10,000,000 project cost and is expected to earn 15% on cost or $ 1,200,000,000 at the end and "rent" Suppose further that the developer is able to secure a construction 75% loan to cost or $ 7,500,000. The capital requirement is $ 2,500,000. The developer will 10% of the capital. Let's further assume the project is a project that sold in conclusion. Suppose it takes years to build and takes the year's rent up. Suppose it is a shopping center leases and anchor initiate the completion and the balance of the leases come in late in the second year. Let's further assume the project is sold to an 8% cap rate with $ 1,200,000 or $ 15,000,000 and revenues of the anchors is $ 1,000,000. The first mortgage will cost by 6%.

Here is a comparison of the advantages of financing mezzanine vs. equity financing:

Advantages of Equity:

1. Generally, you need less cash

2. In the couple of default, risk is less, there is no forgiveness of debt tax liability

3. Mezzanine is additional influence with all its risks

4. In the case of a project thinner than expected can still make money if there is a benefit, but the benefit is less than the required return mezzanine, and which you do not even eliminated.

5. No need to intercreditor and subordination agreement with the senior lender.

6. More equity could result in better loan terms high level.

7. Some senior lenders simply do not like mezzanine loans behind them, or permit the transfer of the interests of the association.

8. No personal guarantees (it may have with a mezzanine).

9. Usually simpler and faster than paper (and less legal fees).

Advantages of Mezzanine:

1. When yields are larger, it is usually best to put more capital and keep a larger portion of the profits.

2. Mezzanine not share in profits, their return is capped

3. Mezzanine has much less control, day after day, are a lender with the lender controls similar to a mortgagee first (though somewhat tighter)

4. The mezzanine investor return requirements are generally lower than those required capital investor (although preferred equity returns are similar to the floor).

In summary, for all the reasons that a borrower may prefer equity vs. mezzanine, the lender may have the same or opposite reasons to desire equity vs. mezzanine. Some lenders do not just equity. Or, you may not be willing to make a distinction between pure equity and preferred equity ( "equity is equity"). In addition, lenders often have LTC / LTV limits by above which they will miss something like mezzanine and begin to expect a return on equity (for example, a lender may decide that anything over 90% require of stock returns). The conclusion is that we have to work for both parties.

About the Author

Mark Hasegawa is a manager at Ocean Pacific Capital. We have specialized in mezzanine financing since 1977.

Ukigumo Kata from Hasegawa Eishin Ryu