Post by Brandon Miller
As we continue to emerge from the recession, the equity capital component of a commercial real estate transaction remains very critical to the success of a deal as lenders’ leverage requirements remain conservative. Perhaps down the road we will see lenders begin to loosen the purse strings – supported by strong fundamentals, of course – but until then, developers and investors should be prepared to put real cash into deals. For many small- and middle-market real estate developers, this shift has created substantial challenges to raising equity, especially on deals requiring less than $2.5mm to $3mm of equity placements.
In the past, developers usually found success in raising equity on smaller deals by “passing the hat around” among friends and family or at the country club by cobbling together enough investors to provide one or two million dollars. Post recession, these same deals may require more equity, and, combined with the effects that the recession has had on this profile of investors, it has become increasingly difficult for developers to pass the hat. Coupled with this, many smaller real investment funds, family offices, etc. that preferred smaller transactions in the past are now looking to do larger investments as they are seeing new opportunities to invest in institutional quality assets or with large developers that were previously out of their reach. Frankly, many investors simply cannot handle the inefficiencies of providing capital in $1mm, $2mm, or even $3mm increments. It’s just easier to deal with larger transactions.
A void has been left in the small equity range. This void will be filled in time as opportunistic investors recognize the demand and potential to receive favorable economic terms for their investment. These groups will be flooded with opportunities as they become known in the marketplace; therefore, it will be important for developers seeking equity to have deals under control as anything that is not teed up and ready to close will get pushed aside.
Dollar amount aside, here is what equity providers are looking for in a deal:
- Basic real estate food groups (i.e. multifamily, retail, office, & industrial) and healthcare are the most popular product types. Land and Hospitality remain very challenging;
- Deals with existing cash flow are preferred over development opportunities;
- 2x multiple on investments with a clear exit strategy;
- Track record of the sponsor.
As an intermediary, MCA is continually finding and identifying new equity providers through its daily efforts of raising capital for real estate transactions. In addition, we are adept at helping to effectively underwrite and structure deals, creating a saleable story, and preparing an equity investment package that will ultimately help a developer solve his investment needs. By casting a wide net at the beginning of any equity assignment, MCA is able to facilitate the placement of a transaction by letting the market “push the cream to the top,” which allows the market itself to “clear” the most appropriate and interested equity providers. A good deal certainly helps catch everyone’s attention as well as larger placements – at least for the time being.