Seeing Most Complex Deals From the Debt or Equity Side?
Looking at working at a debt fund and during the interview process they kept saying they work on interesting, complex transactions. How can they be complex from a lenders perspective? Is it because they are a lot of moving parts and parties, maybe portions of debt are looking to be paid down with owner equity before a refi for a more favorable LTV? Could anyone share a high level example of a complex debt or equity transaction they worked on? I have some equity experience, but in general pretty new to the principal side of the business.
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I’ll PM you.
Just ask the questions here so future users of the forum can learn from the discussion. What are you going to talk about that’s so private ?
I'm at an opportunistic debt fund. We work on a lot of ground up construction around the country as well as closing a bunch of highly structured/complex financings this year. We don't typically release a lot of information publicly, but a lot of what we do makes it way into the news at some point.
can you provide some color on the complexities and what structures you work on for educational purposes? would be cool if you can expand!
Structured financing usually includes seller financing, so the current owner moves to some type of ground lease, new owner owns the building gets a loan on that and then there is mez lending to renovate ect.
These types of deals have alot of players coming to the table and figuring out their pricing based on default and what goes to who first.
Hard to talk specifics wland stay anonymous, but here are a couple of examples:
Lease-up office play:
We signed a term sheet for the senior loan, brought in two others for the mezz (senior/junior/ to complete the stack, and at closing bifurcated the senior into an a/b and sold off the a. Highly structured deal as this was a cash neutral refinance.
Ground up construction industrial:
Sponsor controlled the land, but didn't have a bunch of cash to find the equity. We did a senior stretch, brought in a partner for 1/2, and then back levered the whole loan. As part of the deal, we structured an equity kicker and after the equity is paid a pref, we get 50% of the net profits.
While debt is more removed from the day to day, where we excel is in the financial engineering of a deal. Trying to make sure you get paid for the risk and are adequately covered/have controls is a fine balance. To me it is the perfect mix of RE, banking, and legal quandaries.
Nice. Sounds really interesting
I think the equity side is more complex because you are really creating the entire capital structure from that seat. You are involved in all the details of the senior loan plus maybe a mezz loan and on top of all that you're negotiating the promote/waterfall stuff with your LPs.
My firm is pretty focused on debt and even I agree with this. Must be some insecure debt guys MS’ing
People like to think of debt as "set it and forget it," but what most people don't actually appreciate or think about is that once we make an investment, we have many of the same considerations as equity.
We have to negotiate fees, promote, etc with our LPs/SMAs. We have to manage the performance of our assets via the controls that we have in our loan documents, and we have to act as investors and make decisions on when to hold, buy, or sell to produce the best returns possible.
Just because a loan has a face rate of sofr+500 doesn't mean that I'm just making a soft+500 return, I probably engineered a 10+% for myself using back leverage or by selling off a senior piece.
Example: I make a loan for SOFR+500 for 75% LTV. But then I sold the 0-50% LTV tranch for SOFR +300. So I'm holding 1/3 of my initial loan (the 50-75% LTV slice) and making sofr + 900 on my slice (500+200 I scraped from the 0-25% slug +200 I scraped from the 25-50% slug). Then you add the 1% fee that I scraped and now I'm sofr+1200. So I took a sofr 500 whole loan and turned it into two pieces, a sofr +300 slug from 0-50% LTV and a sofr+1200 slug from 50-75% ltv.
It is all actually very similar, our products are just different. Equity's product is an actual building with a business plan. Debt's product is a loan backed by a building with a business plan.
People not understanding debt and how we make money was the catalyst for the GFC. It wasnt the underlying real estate, it was the financially engineered/structured debt products that were purchased at rates lower than the proper risk adjusted returns, allowing sellers to produce very outsides returns for themselves. At the time, it was basically like printing your own cash because you could do what I said in my example, but instead of holding 1/3 of the loan, you could sell 100% of the loan, but still be able to scape the difference because what you priced the loan at and what you sold it at. Back then (and to an extent still), it was very little risk (essentially 0 dollars invested) but super high reward which could produce essentially an infinity IRR. Updated regulations tried to cure the problem, but just because you disclose something doesn't mean that your investors actually read the notes and figured it out.
Wouldn't the S+900 with the 1% fee really be S+1000 not 1200?
900 as in 900 basis points aka 9%, plus 1% = 10% no?
brilliant comment. can you recommend some material to read further into back leverage
Important caveat that equity GP side is more complex. LP side isn't that different from debt, both sides are investing the GP's business plan. As noted below, the debt provider is likely using back leverage to increase their returns and these lines are a lot more complex than your standard standard senior financing.
I work on both equity and debt. I find equity more interesting, but the debt side way more complex. There is way more complexity into the structure of the deal aside from the financials. At the end of the day, though, it’s all financial engineering in some way as mentioned above to ensure you are getting paid the appropriate amount for the risk.
Could you elaborate on what you found more interesting about equity?
I interned for a debt fund and they did some complex stuff.
They had one deal where they made a loan to a whisky company secured by $50mm+ of whisky in barrels. Simple in a financial sense that it’s a secured loan but tricky to actually value the reserves. Another was a sale-leaseback for large cargo ships. They had to take into account scrap values in 25 years and value the ships as they technically owned them. Really interesting debt deals that are far from a run of the mill loan
Some of the corporate credit deals are absolutely insane.
I've seen loans that are backed by airplanes/airplane leases, jewelry/luxury goods inventory, sports teams, and even HVAC parts.
Some of my favorite deals to hear about at IC because they are so complex and the documents are written so tight on controls.
In my experience it isn’t the finance aspect it is more so structuring the loan.
An example is cross collateralizing multiple value-ad properties that have .95 debt services and may or may not have proper insurance/zoning/parking.
What's .95 debt services? Not super familiar with some of the terminology and structure. Why wouldn't they have proper insurance, zoning, or parking could you talk about a general example?
I'm assuming he means debt service coverage ratios, which is a ratio comparing NOI to debt service (aka loan payment obligation). a 0.95:1.00 ratio means that there is only $0.95 of NOI for every $1 of debt payment due. So NOI is insufficient to cover debt payments. this is common on value add deals, you just structure around it with an interest reserve and completion/stabilization guaranties from the sponsor.
That means the debt service (how much they pay the lender each year) is greater than the NOI. Cross-collateralization lowers the risk because if one loan goes bad, they all go bad. It is more common than you think to have an issue with something city related but usually, it is never a big deal and can be sorted relatively quickly (and it will also be in the loan agreements that they do so). A common example is an older apartment that is short a few parking spots per city code.
Let me turn that question around - What about the equity side do you think is more complex than the debt site? Do you think debt underwriting is just a simple LTV + DSCR calc and a yes/no?
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