by Greg Brown, Head of Real Estate
The majority of conversations I am having right now with real estate owners and developers center around recapitalizing existing assets. Rather than using debt – which, don’t look now, has crept up another 25bps – they are going to use fresh equity. Unfortunately, most owners only think of raising equity when considering NEW deals. I can understand that way of thinking prior to access to “General Solicitation” and the possibility to raise private equity online. But in the post-JOBS Act era of capital formation, raising equity for existing assets has distinct advantages for both the owner/issuer and investors.
There is still significantly more equity looking for good deals than attractive deals can be found
Deal and risk assessment are more quantifiable for investors looking at a deal offered by a sponsor that already owns the property. When investors are looking at deals sponsors are proposing to acquire, they are only able to review projections or estimates. But when having the opportunity to invest in a deal, already owned by the sponsor, , investors are able to evaluate the operating history with the operator still in place. Investors can potentially have a greater level of confidence that the asset will continue to perform because operational ownership is not changing.
Deal sponsors can often be patient in bringing in new capital because there is not a deadline to close, as there is when raising capital to acquire new property. This usually drives the cost of new investor capital down.
Sponsors can utilize several different structures to bring capital into their existing deals. They can bring in a new limited partner directly into an existing entity. They can aggregate investors into a new entity and have that entity invest into the deal. They can set up a fund (which does not have to be a REIT) to be spread across several assets owned by the sponsor/operator.
These funds might be my favorite type and are getting the most traction with owners/deal sponsors as they can be a win-win. They are a win for owners because they can spread capital around, based on need. And they are a win for investors because they’re able to achieve diversification across several assets. These funds will often, but not always, carry some level of owner guarantee that single asset investments do not.
Hedge vs Overall Market Conditions
I only went to a state school, so I’m not qualified to opine on when the overall or real estate markets will turn. But I do know that no bull market lasts forever and there will be a slowdown. We are seeing what the debt markets are doing, with most real estate related interest rates now at 5% or higher. HOWEVAH (copyright, Steven A. Smith, ESPN) that does not mean equity demands have followed. What I mean by that is that there is still significantly more equity looking for good deals than attractive deals can be found. This will even increase (in my humble, state school-educated opinion) as investors look for more exposure to real estate. A deal sponsor, when considering recapitalizing existing assets, needs to look very hard at using equity rather than debt. Especially, for example, if an interest rate is 5-5.5% (with the associated fees, application process, bank inflicted brain damage) and preferred equity could be secured for under 7%, which is what we are seeing in some cases.