Commercial Real Estate development by all accounts is a simple business concept (over simplified below):
1) Find a Location;
2) Design a Building;
3) Secure Financing;
4) Build Building;
5) Lease to Tenants;
6) Collect Rent; and
7) Pay Mortgage.
The most simple of plans often seem the most difficult to execute. While most of the above seem straightforward and within the control of the Sponsor to go out and achieve with a good business plan, hard work, and determination, unless you are a modern day Rockefeller, there is one particularly significant step that often suffers at the whim of factors outside the Sponsor’s control.
“If you would know the value of money, go and try to borrow some .“ ̶ Benjamin Franklin
Most Sponsors have a pretty good handle on what their industry is doing and how money is priced for deals like theirs. It is just human nature to think that “Your Deal” is a “Great Deal” and therefore should be priced at the best economic structure one might hear from your circle of industry professionals. Sound familiar?
It is true that because commercial real estate is so efficient and competitive, many deals seem to require the highest leverage, the lowest rate, the longest amortization in order to provide enough cash flow for decent equity returns. Those are tough deals, and not for the faint at heart! Those high-risk deals require a very well-heeled Sponsor, who has an excellent track record of execution. These deals often best lend themselves to a Sponsor with deep pockets, who will invest his money and de-leverage the transaction in order to realize a more sustainable return. A good example is the REITs who brought so much price compression into the commercial real estate markets over the last 15 years.
While money might seem like a commodity to many Sponsors who are searching for it, those, who have the money, do not view Sponsors as Commodities. Each Sponsor is unique with his set of risks that when combined with the risks of a real estate deal create a global picture for the financing source to consider. It is the global view of the sponsor that capital providers contemplate when they make a decision to provide financing or more commonly when they price and structure their money. The factors are too numerous to consider in a mere essay/blog, but some include existing relationships, industry experience, past performance, tenant information, market conditions, specific capital market conditions, and the financial / balance sheet concerns every lender highly stresses.
Adequately describing the Sponsors global economic picture for capital providers to see is part of what a good real estate finance intermediary brings to the table. Exactly how the financier presents the sponsor’s story is often the “Jump Ball” on whether a deal proceeds or not. Knowing the business behind the company of a Client/Borrower is crucial for the financier’s ability to execute CRE transactions. The last thing you ever want is to make a Borrower look like a commodity.
The author, Kevan McCormack, is a Senior Director in the Dallas office of Metropolitan Capital Advisors. Contact Kevan at firstname.lastname@example.org