Remington Capital

Capital Stack is a term that gets used a lot in our industry but is not well understood by many brokers new to commercial finance. In a commercial transaction, there is usually a mix of types of financing that combine to create the capital stack. If you were to look at a diagram of the capital stack you would find that as you worked your way up the stack, the financing becomes more risky to the investor and thus requires a greater return.

• Senior Debt – At the very bottom of the capital stack is senior debt. Senior debt usually makes up 50-70% of the capital stack. Senior debt can include fixed rate loans, floating rate loans, construction loans, bridge loans and hard money loans.

• Mezzanine Debt – In the middle of the capital stack is mezzanine debt. Mezzanine debt is subordinate to senior debt, so the risk is higher to the lender. Mezzanine debt is typically used to add additional leverage beyond the 50-70% provided by the senior debt. Adding an equity component to the mezzanine debt results in a participating loan or hybrid mezzanine loan.

• Equity Financing – At the top of the capital stack is equity financing. Equity is different from debt in that the investor participates in the success of the project being financed for a set period of time. Equity capital can include preferred equity, joint venture equity and/or sponsor equity

As a commercial loan broker, your clients count on you to help them secure the financing they need from options across the capital stack.

With plans in place to close 200 underperforming stores by the end of April, Borders Group Inc. will be seeking retailers to lease approximately 4.9 million square feet of retail space. Fortunately for Borders, retail vacancy is set to drop 10% by the end of the year and retail is steadily rebounding. http://bit.ly/fQWEVz

According to a new report by Colliers International, the U.S. office market entered the year on a relatively strong note after the fourth quarter, with a sharp drop in vacancy and a healthy increase in occupied space. But rents continue to languish, according to Ross Moore, chief economist at Colliers International and author of the report. The fourth quarter marked a key turning point toward recovery, he says. “With the economy now posting robust growth, all that is needed for a full recovery is a surge in employment.”

With the economy making strides, and the addition of private sector jobs, leasing markets are expected to continue improving as 2011 unfolds. The fourth quarter data confirms his view that the U.S. office market has entered the recovery stage and will likely make continued progress, assuming the economy stays on the current path, says Moore. Most encouraging is the 12-month-long gain in private sector employment, he adds.During the October-December period, professional and business employment was up 2.2% year-over-year, the report says. Widespread rent increases are still unlikely anytime soon, according to Colliers International.

The U.S. national office vacancy rate moved substantially lower during the fourth quarter, dropping 29 basis points, with 100 basis points equal to 1%. This represented the first drop after 12 quarters of rising vacancy. Office vacancies finished the quarter at 16.11%. Moore expects that to mark the beginning of a long decline in vacancy.

During the fourth quarter, downtown vacancies decreased 23 basis points to 14.81%, while suburban vacancy rates fell 32 basis points to register 16.69%.For the year, the U.S. national office vacancy rate fell 12 basis points after peaking in the third quarter.

During the ‘CMBS Outlook’ session at the Mortgage Bankers Association’s Commercial Real Estate Finance and Multifamily Housing Convention & Expo, Jack Cohen, CEO of Cohen Financial, clearly explained the position that many borrowers are going to be in this year as banks begin to take losses on the loans that they had previously been extending.

Mr. Cohen’s is correct that some resolution has to be reached on the loans that banks have been extending for the last year before the market can fully “reset”. However, the only option for the borrower in his example isn’t just to pack it up and go home; recapitalization gives borrowers a chance to revitalize their projects and not lose the time and money they have already invested.

“My belief is that that the reset button can’t be hit until this industry takes its losses. The problem that exists is that the institutions are more capable to take their losses, both intellectually and economically. They’re creating revenues, they’re creating reserves, they’re writing stuff off.

“But the guy who has a $5 million shopping center and a $4 million loan, and who has $1 million in it and is going to lose $3 million or $4 million — that guy is toast.

“But it has to happen. This business is about risk. You are supposed to make a lot of money and lose a bunch of money. Guys who lose leave the game. Guys who win keep coming. So, people are going to have to take some losses. Until they do, we’re not done.”

-Jack Cohen, CEO of Cohen Financial

In most cases, if your client is looking for 80% LTV on senior debt, you’re going to have a hard time finding them the capital they need. Understanding the capital stack will allow you provide your client with some industry expertise and quite possibly a more feasible capital structure.

Suppose your client has $2 million in senior debt on an apartment complex that represents 50% LTV. Your client is calling you because he needs another $1.2 million to complete upgrades and repairs, but the bank won’t refinance his project up to 80% LTV. You could spend time trying to find a lender who would refinance this project up to 80% LTV, and if you were lucky enough to find someone the interest rates are likely to be higher than the financing currently in place on the project. Perhaps a better suggestion would be to secure mezzanine financing to supplement the existing loan and get the total financing up to 80%.

As compared to financing for residential properties, commercial properties are much more unique and seeking the correct type of financing is more nuanced. This is also one of the reasons that your clients need your expertise to help them get the financing they need.

According to recent polls conducted by NREI, investors in senior housing report that occupancy rates have declined as a result of the condition of the housing market, as well as the overall economy. There were mixed opinions on when occupancy rates would begin to recover, but most agreed it would be this year.

Because the volume of commercial real estate sales nearly doubled in 2010 from $54.6 billion in 2009 to over $100 billion, financial institutions now have a basis for establishing pricing which will allow them to decide whether or not it is in their best interest to foreclose on commercial properties in default. Here is a recent article on the subject: http://bit.ly/gZ75xw

REITs are one of the largest sources of private capital for real estate investments. REITs that invested in debt secured by commercial and residential real estate seemed especially successful, in some cases posting total returns over 200% for the year. Is there capital available for commercial projects in today’s market? The answer is yes; private sources of capital have been very busy in 2010 and will continue to provide capital for commercial projects through 2011.

Many experts in CRE will tell you that the office segment of the CRE market was one of the last to be impacted by the downturn and will be one of the last to recover. Does this mean that there is currently no financing available for office projects? Yes, financing is available for good projects. http://bit.ly/dQB4eH

Large retailers like Wal-Mart and Target have recently started to aggressively bid on vacant big box properties. In some cases retailers are outbidding investors by 20-30%. Since the properties are able to be acquired at massive discounts, the cost of occupancy for properties purchased by the retailers today will be much lower than if they were to lease the property from a developer. Ownership of the properties will also allow the retailers greater flexibility in making changes to the buildings.