As I'm sure you know by now, my focus is creating structured bridge financial transactions for real estate investors. This article will attempt to explain common industry terms and how a deal is structured. I can't count how many times I hear the term investor used to describe 3 different players in the same transaction. For example, is the investor the equity participant, is it the lender, or is it the real estate operator setting up the deal? Let's go through it step by step by describing a typical transaction.Sponsor: The company or individual who is looking to raise money and has identified the real estate to be purchased or improved.
Investor: The money partner, sometimes an individual, sometimes a company, (private equity group) who is putting up the cash above and beyond leveraged or bank money. However, if 100% of the money needed to complete the project is debt, then the term investor might be used to describe the lender or debt partner.
Lender/Debt partner: The institution putting up the loan.
Structured Financial Transaction: Any deal structure where debt and equity are both used together to finance a deal.
Debt: The capital piece structured as a loan. It could be based on a percentage of purchase price (LTV or loan to value basis) , the future value once the project is finished, or it might be based on the cost to purchase in combination with the improvement costs and project expenses (LTC or Loan to cost)
The most asked question I hear is, “What does the equity share partner want in return for their money?” There are an infinite number of ways to structure a deal but I'm going to explain the two most common ways to calculate that number.
Pari Passu: Example 1: $1 million is the total cost projected for a purchase rehabilitation project on a 5 unit apartment building.
Use Of Funds: $595,000 purchase price*$250,000 for rehabilitation*$90,000 for Real Estate Broker Fees*$15,000 for mortgage brokerage fees*$25,000 for interest reserves*$25,000 for legal costs. Let’s say the sponsor has secured a $600,000 loan and put up personal guarantees for that loan. There is now $400,000 still needed to cover the project.
If an investor brought in $200,000 total and the sponsor put in 200k of his own money, then the deal would be split 80/20. 80% going to the sponsor and 20% going to the investor. 600k bank loan credited to sponsor. 200k credited to sponsor. 200k credited to investor = 80% to the sponsor and 20% to the investor.
Pari Passu: Example 2: $1 million is the total cost projected for a purchase rehabilitation project on a 5 unit apartment building.
Investor: The money partner, sometimes an individual, sometimes a company, (private equity group) who is putting up the cash above and beyond leveraged or bank money. However, if 100% of the money needed to complete the project is debt, then the term investor might be used to describe the lender or debt partner.
Lender/Debt partner: The institution putting up the loan.
Structured Financial Transaction: Any deal structure where debt and equity are both used together to finance a deal.
Debt: The capital piece structured as a loan. It could be based on a percentage of purchase price (LTV or loan to value basis) , the future value once the project is finished, or it might be based on the cost to purchase in combination with the improvement costs and project expenses (LTC or Loan to cost)
The most asked question I hear is, “What does the equity share partner want in return for their money?” There are an infinite number of ways to structure a deal but I'm going to explain the two most common ways to calculate that number.
Pari Passu: Example 1: $1 million is the total cost projected for a purchase rehabilitation project on a 5 unit apartment building.
Use Of Funds: $595,000 purchase price*$250,000 for rehabilitation*$90,000 for Real Estate Broker Fees*$15,000 for mortgage brokerage fees*$25,000 for interest reserves*$25,000 for legal costs. Let’s say the sponsor has secured a $600,000 loan and put up personal guarantees for that loan. There is now $400,000 still needed to cover the project.
If an investor brought in $200,000 total and the sponsor put in 200k of his own money, then the deal would be split 80/20. 80% going to the sponsor and 20% going to the investor. 600k bank loan credited to sponsor. 200k credited to sponsor. 200k credited to investor = 80% to the sponsor and 20% to the investor.
Pari Passu: Example 2: $1 million is the total cost projected for a purchase rehabilitation project on a 5 unit apartment building.
Use Of Funds: $595,000 purchase price*$250,000 for rehabilitation*$90,000 for Real Estate Broker Fees*$15,000 for mortgage brokerage fees*$25,000 for interest reserves*$25,000 for legal costs. Let’s say the sponsor has secured a $600,000 loan and put up personal guarantees for that loan. There is now $400,000 still needed to cover the project.
If an investor brought in the 200k and the sponsor brought in 200k, the deal would be split 50/50. Why the big discrepancy? Some investors count debt brought into a deal as money contributed by the sponsor while others do not. In this example, the 400k remaining gets 100% of the deal so 200k equals 50% of the deal and the sponsor and investor split the deal 50/50.
Understanding the subtle deal points and perspective of both sides of a deal empower both an investor and a sponsor. If you are providing the service of helping raise capital for your clients, you earn your commission and placement fees by helping structure the transaction through understanding the deal points.
If an investor brought in the 200k and the sponsor brought in 200k, the deal would be split 50/50. Why the big discrepancy? Some investors count debt brought into a deal as money contributed by the sponsor while others do not. In this example, the 400k remaining gets 100% of the deal so 200k equals 50% of the deal and the sponsor and investor split the deal 50/50.
Understanding the subtle deal points and perspective of both sides of a deal empower both an investor and a sponsor. If you are providing the service of helping raise capital for your clients, you earn your commission and placement fees by helping structure the transaction through understanding the deal points.
Preferred Return: Many sponsors offer a preferred return to their investors based on an annual percentage. This is the investors guarantee. All profits beyond the preferred return can be sliced and diced based on negotiation. Some sponsors keep 100% of those profits. Some do a split.
There again are many more deal points when structuring a real estate investment but the Pari Passu and Preferred return examples are a great place to start. Remember, if a sponsor is looking for investment capital and is asking for more than a lender will loan, typically more than 60% LTV or LTC, then the investor who brings money to the table to bridge that gap deserves a higher return than the bank. If the sponsor is asking for equity, they will have to pay for it.
To your Wealth!
Russell Roesner
Equity Coalition President
San Francisco, CA 94121
Thank you, this is very helpful. Working on my MSRE and completing a case study for class.
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