Finding Private-Equity Answers
Financing solutions could exist for clients who might otherwise pass on a good deal
By Craig Grella, co-founder, Cornerstone Funding Services Inc.
In today’s tight credit market,
most conventional mortgage lenders —
such as commercial banks and insurance companies — are falling back on time-tested, conservative underwriting methods.
This includes requiring low loan-to-value
ratios (LTVs); high borrower liquidity and
net worth; and stable, low-vacancy assets.
It’s likely harder for many of your clients to
get high-leverage loans, and they’re often
required to put up a larger cash outlay —
receiving a lower return on investment.
Thus, many would-be property-buyers
sit on the sidelines to wait out the market, and the volume of brokered deals is
decreasing significantly. As a mortgage
broker, however, you can help your clients
move forward with their deals by helping
them find private equity.
Your clients don’t have to pass on a
good deal just because they’re short on liquidity. Many companies offer private equity for real estate transactions, and they
operate much like private loan sources.
The major difference is that the money
your client receives is not treated like a loan,
and private-equity lenders do not take a
subordinate-note position behind the first-lien lender. Rather, their money goes into
the pot upfront with your client’s cash equity. In return, the equity firm receives a
split of the cash flow and a split of the profits when your client sells the property.
Finding private equity isn’t always difficult.
In fact, most investors find their first level
of private equity from family members,
friends and close associates.
If your clients don’t have contacts with
cash, you can help them dig deeper and get
more creative. Make a list of local note-buyers, private lenders and others who
have experience investing in commercial
real estate and who understand the risks.
To win private-equity investors’ money,
your client must first earn their trust. To
do that, the client must demonstrate the
merits of the investment while showing its
potential to generate high returns. Your
client can do this by highlighting certain
property features, including:
■ How much equity is required;
■ The level of your client’s investment
compared to the needed investment;
■ The investment horizon or holding
■ The property’s monthly or yearly cash
■ The exit strategy — will your client refinance the property in three years or sell
■ How much of the monthly cash flow
and profit from sale the investor will get
in return for the equity.
Determining the cost
There is no standard rate of return for private equity. Some investors will require a
simple 10-percent to 15-percent annual return. Others will ask for a split of the cash
flow commensurate with the ratio of their
investment; a portion of your client’s exit
cash flow; an overall yearly rate of return
that could be greater than 20 percent; or a
combination of these.
Private equity, like private loans, can be
expensive. But if it helps your clients get
the deal done while still making an acceptable rate of return, then you’ve achieved
your goal and theirs.
Consider this example: If your client’s
investment requires $100,000 of equity, but
your client has only $10,000 in cash, then
the additional $90,000 — or 90 percent
of the total equity — is required. For that
level of investment, some private-equity
investors will require a rate of return of 90
percent of the monthly cash flow. Further,
when the property is sold, they may want an
additional 15 percent on their investment.
Thus, if the property generates $2,000
in monthly cash flow, the investor would
receive $1,800 per month. When your client sells the property, the investor would
get the initial investment back, plus 15
percent, to equal $103,500. This leaves
$200 per month for your client, or $2,400
per year, a 24-percent cash-on-cash return for every year your client holds
Other investors may take less upfront,
but they may want higher returns on
the back end. That would give your client more of the monthly cash flow and a
higher return, but the back end benefits
the investor — so much so that your client might not receive any money upon the
property sale. In that case, your client is
in it only for the cash flow.
Presenting the opportunity
Find your client’s rate of return by analyzing the property’s cash flow, adjusting for
variables. Your clients use this to present
to potential equity investors. Clients will
highlight the investment’s profit-generat-ing potential and the equity investor’s potential profit.
Advise your clients to present the investment in the best light, including:
■ Giving investors an upfront overview
in a few sentences so they know what to
expect from the presentation. Does the
project offer above-average returns? Can
they get special financing? Are they picking
it up at a discount?
■ Putting the project in context from
a macro level, geographically and conceptually. Present an area map and a site
■ Having a complete financial analysis
that shows all costs, value creation and the
potential for the investor’s return on equity.
Your clients should explain their exit strategy thoroughly and also address the risks
and their plan for mitigating those risks.
■ Incorporating all team members; and
■ Leaving time for questions.
The better the presentation, the more
likely your clients will receive the equity.
In addition, when your clients accept
money, make sure they and the investors
are acting lawfully. An attorney can advise
them on securities regulations that may
come into play.
■ ■ ■
Craig Grella, co-founder of Cornerstone Funding Services Inc. — a full-service
real estate consultancy with offices in Long Island, N.Y., and Seattle — started
his career as a civil and structural engineer. Working with developers made him
aware of the challenges of commercial and development financing. As such, he
transitioned from designing projects to financing them and worked as a senior
loan officer with several national banks. Contact him at (800) 928-0845 or visit
Many commercial property-buyers pass
up deals for which they think they can’t
immediately find financing. Doing so may
cause them to miss potentially profitable
deals. By helping clients find private-equity
partners, you can help make sure they don’t
make the same mistake.
As their broker, if you also can educate
your clients and help them find private-equity sources, you can collect fees on the
equity raised in addition to the fees associated with the bank loan.
Illustration: Dennis Wunsch