Stephen Counts is vice president of Envoy Net Lease Partners
in Northbrook, Illinois. He has a background in net-lease
investment sales and commercial real estate finance, and
is responsible for reviewing incoming deals, assisting with
client signings, compiling deal packages and underwriting
loans. He previously worked with CBRE Capital Markets’
debt and structured-finance team, as well as Calkain Co., a
net-lease investment company. Reach Counts at (847) 239-7250.
Ralph Cram is president and manager of Envoy Net Lease
Partners in Northbrook, Illinois. He is responsible for strategy,
marketing and investment advice on all aspects of net-lease
property investments in single-tenant retail, industrial, office
and medical properties. He co-founded Envoy in 2011 and
has under written, acquired or financed $1.5 billion in assets
during his 25-plus years in commercial real estate.
Reach Cram at (847) 239-7250.
Private-Equity Debt Can Save the Day
Try out a financing option for deals that don’t fit with traditional lenders
By Stephen Counts and Ralph Cram
Private-equity real estate debt financing is on the rise. Preqin’s 2017 Global Real Estate Report indicates that aggregate debt-focused target (or optimal) capital increased by 6. 45
percent year over year as of January 2017, to $33 billion.
There is increased demand for investors seeking to
place their money in debt and equity funds focused
on real estate. Pension funds, endowments, foundations and other commercial real estate institutional
investors are adding debt-focused funds to their real
estate investment options to chase higher yields in a
low-yield environment. This expanding private-equity
landscape is creating additional financing options that
can help commercial mortgage brokers better serve
Private-equity debt funds have been an increasing
option for borrowers because banks are required to be
more cautious in lending under tighter bank regulations.
Pre-recession, there were numerous lending resources
providing aggressive construction and bridge loans, but
that is no longer the case.
This undersupply of capital from traditional lending
sources, such as banks, has created an opportunity for
private-equity funds to fill the void. Some banks are
still involved in the private-equity space by providing
warehouse credit facilities to private-equity funds for
lending purposes. Most banks have reduced their exposure to construction lending in the past three years.
When banks extend credit to nonbank lenders, it is
less risky than making loans directly to property owners.
The private-equity funds take on the risk, protecting the
bank from losses. Because private-equity funds generally
have a higher cost of funds than banks, private-equity
debt financing for long-term, stabilized, low-risk deals
will not likely be the best solution. There are numerous
circumstances, however, in which private-equity debt
does make sense.
Void in the market
Private-equity debt is not cheap capital, but it addresses
a void in the market. Through debt financing, private-equity funds are filling a need that other traditional
lenders are not willing to consider.
Traditional lending sources tend to focus on conservative investments in traditional property types like stabilized retail, office, industrial and multifamily. When a
property does not “fit the mold,” traditional lenders will
pass or will offer very conservative terms. Many banks,
for instance, will not lend on development deals, and
the ones that will require a low loan-to-cost (LTC) ratio
of 50 percent to 70 percent.
In comparison, private-equity debt will, in some
instances, go close to a 100 percent LTC ratio. Private-equity deals will often involve construction development, value-add properties, lesser credit, secondary
locations, opportunistic strategy, less-than-perfect
borrowers and other factors deemed undesirable by
Quicker and less restrictive
Private-equity debt requires a higher interest rate than
capital borrowed from traditional sources like banks,
insurance companies, commercial mortgage-backed
securities (CMBS) lenders and government agencies.
Private-equity funds, however, can process loans
quicker because of their less bureaucratic approval
and underwriting process.
In some cases, borrowers can close deals in fewer than
14 days. In many cases, for developers, the speed and
certainty of closing can result in increased profitability
even with the higher cost of capital, compared with the
less-expensive bank capital offered by lenders who may
not close the deal on time — creating a risk that the developers will lose their escrow deposit and upfront capital.
Traditional lending sources often are restrictive on
where they are willing to lend. Large banks often focus
only on major markets, and regional and local banks
require deals within their region.
This requires national borrowers to have a network of
different banks across the country when using traditional
capital. Having multiple lenders can result in decreased
efficiency, longer processing times, and increased paperwork and risk.
Private-equity funds are less restrictive on location,
which allows national borrowers to partner with the
same private-equity company on their entire pipeline.
When the borrower has already been underwritten,
the process times and paperwork on each deal shrink
significantly, and loans can close faster.
Many traditional lending sources need to “check all the
boxes” and provide very little flexibility outside their
underwriting guidelines. But private-equity funds can
be more flexible with borrowers when managing and
evaluating risk. Banks are required to hold a fixed percentage of cash against different types of commercial
real estate loans, while private-equity funds have more
flexibility when it comes to capital reserves.
If an issue in underwriting and due diligence arises,
then private-equity funds can, in many cases, work
around the issue or offer more flexible solutions than
When a deal does not work with private-equity debt
alone, it might still qualify for joint-venture equity, or
both. In some cases, a deal may not qualify for private
debt because of credit issues. Private-equity funds can
still make the deal happen by providing joint-venture
equity. Because of the difference in structure between
private debt and joint-venture equity, the latter can
mitigate some of the concerns that are difficult to
overcome with private debt.
The cons of private-equity debt are the cost of capital and generally shorter terms. Private-equity funds
require a higher cost of capital to generate accretive
returns, or post-transaction value, for the fund investors. The lifecycle of private-equity capital is usually
shorter than its traditional-lending counterparts. As
a result, private-equity funds are not likely to provide
long-term permanent loans. Private-equity funds, in
most cases, will be pushing the borrower to repay the
loan in less than 36 months.
n n n
Private-equity funds find debt financing attractive
because it offers consistent cash flow and it offers
less risk than joint-venture equity investments. Debt
financing provides an opportunity for these funds to
get a decent yield and, in some cases, returns similar to
mezzanine debt. Going forward, private-equity debt
should be an increasing and reliable source of short-term funds for borrowing in cases of a nontraditional
loan request. n
“When a deal does
not work with
it might still
equity, or both.”