Commercial Loans & Mortgage News - February 26, 2002
Trapped Equity Mezzanine 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!
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Chief Executive Officer Peter Slaugh founded Steelhead in 1999. In the relatively short period since its inception, Slaugh has built Steelhead into a leading resource for debt and equity placement nationwide. Slaugh is primarily engaged in growing the company and its lender relationships, as well as working on financings.
San Francisco Offices
With an extensive lender network, Steelhead Capital has built its reputation on structuring commercial loans requiring both debt and equity placement. Fluctuations in the capital markets present significant challenges for investors and we are pleased to provide financing as well as guide and advise clients through the process. Whether you are looking for apartment financing, commercial financing, mezzanine financing, or creative "out of the box" real estate loan alternatives, we can help.
For apartment loans below $2 million, we have a small apartment loan program with extremely competitive rates. For apartment loans and commercial mortgage loans above $2 million, we provide direct access to the country's most aggressive lenders. Make Steelhead Capital a part of your commercial real estate financing success. We look forward to hearing from you soon.
Please click here for your confidential and complimentary loan review. Are there more questions that you'd like answered? Contact us online, or call our executive team directly in our new San Francisco office at 888-951-6600.
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