February 26, 2002

Commercial Mortgages & Real Estate Loans:
Trapped Equity Mez Financing

In our last edition, we discussed the growing need for mezzanine financing based on the apparent disconnect taking place between available debt and the level of equity required for acquiring commercial real estate investments. What we didn't cover was the scenario in which the property's value has increased as a result of strong management and/or increasing Net Operating Income. In this scenario, owners find themselves with an asset that is potentially "under-leveraged" given recent appreciation gained through proper management or increased rental income. In most cases where lenders impose stiff prepayment penalties, refinancing can be extremely cost prohibitive thus trapping equity as well as limiting marketability to other investors. Potential buyers are required to raise additional equity if they are considering assuming the existing debt. In either case, the inflexible nature of the first mortgage precludes the owner from capitalizing on the asset's appreciation.

Steelhead Capital has a solution to this scenario through one of its capital sources. The program is known as "topping off the tank", and is designed to allow owners to borrow up to a conventional lender's current LTV parameters: 75% for commercial properties and 80% for multifamily. Take the following example with an office building purchased for $10mm five years ago. At the time, the investor probably borrowed 75%, or $7.5mm. As tenants renewed at higher market rents, the property may now be worth $12mm with its increased cash flow. The positive change in value puts the existing loan at 62% LTV, and the investor has $1.5mm in trapped equity vs. what he/she could borrower based on today's value. Further, prepayment penalties preclude the owner from paying off the existing note and borrowing at the 75% level.

Because most first lien holders won't allow secondary financing, the program uses a pledge of partnership interests as collateral vs. recording a second lien against the property. Many mezzanine lenders attempt to obtain inter-creditor agreements to allow for secondary financing; however, these instruments between the first and second lien holders are extremely difficult to obtain and this program doesn't require them.

Typical of most mezzanine lending programs, pricing for this structure is higher than conventional lending. Interest rates are set at approximately 800 basis points over the US Treasury that most closely corresponds with the remaining life of the first mortgage, and several points are charged for the transaction. As stated in the last newsletter, this can viewed two ways: expensive debt or cheap equity, i.e. a 12% interest rate plus fees is far less expensive than raising straight equity from investors. We're seeing this program utilized for the following purposes: to further improve the property, to cash-out the owner, or to use the proceeds to purchase another asset - thereby, potentially creating a vehicle to 100% finance another investment.

Give us a call if you want to learn more about this program and how it can work for you!

Read the next commercial mortgages & loans newsletter "From the Street"

Commercial Mortgages & Real Estate Loans Newsletters

About once a month you will receive news regarding commercial mortgages and real estate loans with our newsletter "From The Street." Click here to subscribe and receive your first commercial mortgage issue within just minutes - it's free!

With an extensive lender and commercial mortgages network, Steelhead Capital has built its reputation on structuring commercial mortgages and commercial real estate loans requiring both debt and equity placement. Fluctuations in the capital commercial mortgages present significant challenges for investors and we are pleased to provide financing, as well as, guide and advise its clients through the process of obtaining commercial mortgages. Whether you are looking for apartment financing, commercial financing, commercial mortgages, or creative "out of the box" real estate loan alternatives, we can help.

Our success is measured by our clients' success, and our mission is to be your source for the most appropriate - and advantageous - commercial mortgage solution that helps you achieve your goals. Make Steelhead Capital a part of your commercial mortgage and real estate financing success. We look forward to hearing from you soon regarding our commercial mortgages and real estate financing services.

Call us today toll-free at 888-951-6600 or click here for your confidential and complimentary loan review.