In my real estate private equity book I've been reading, it seems like it happens from time to time, especially if the LP can secure lower rates, but I'm wondering in practice how often this really happens. I would have thought LP's would be extremely reluctant to take on any guarantees.
Thanks.
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Co-Garuntee? You mean like carve outs?
I think what you mean is participate in the recourse, in the event of a recourse loan. I've seen both. I've also seen cases where the developer is 100% guarantor for the loan, and the JV Partner isn't involved. Sometimes this added risk is baked into the agreed upon rates. Other times, I've seen developers set up a priority guaranty payment. This is typically structured as a % (typically anywhere between 50bps-150bps) of the outstanding recourse on the loan. Presumably there is a burn down on the recourse based on agreed upon covenants (C/O, DSCR achievement, occ %, etc.), so the guaranty accrues. This payment is first priorty oftentimes paid out before the preferred rate of return or any other hurdle. Sometimes it's structured as a fee, but often is put as a priority hurdle in the waterfall for favorable tax purposes.
Of course the JV Partner can also too share in the loan recourse and guaranty risk...I'm not sure there would be any ADDITIONAL obligations to the deal, rather it would be baked into whatever the agreed upon rates were...meaning perhaps a slightly less favorable split and promote for the developer? Though I'd imagine this favor to the JV would be most baked into the pref...as by the time any splits and promotes are occurring, most likely the recourse on the loan is largely burned down..
Hope that helps!
Why on earth would you take on any responsibility or risk as an lp? Personally if I was asked to co guarantee anything other than participating in a full recourse loan I would want to be a gp.
You like the deal and the GP who brought you the deal doesn’t have the ability to guarantee the loans. You can either not do the deal, or guarantee the loans and do the deal. It usually means the promote isn’t as favorable as would be otherwise to the GP. Everything is negotiable.
Interesting. How would you use this as a thoughtful negotiating tactic the get the LP to guarantee the loan when the GP can't? In other words "hey LP, this is a great deal that you should invest in. But, oh by the way, we can't guarantee the loan so it's gotta be you." sounds like a scheme.
Is it as simple as offering a couple more percentage points to take on the risk? Obviously deal dependent but just curious how you'd work through this angle when talking to the LP.
Some institutional LPs offer themselves up on the carve-outs and/or recourse. Less common but sometimes depending on the lender/GP, they may be comfortable doing so. Not sure how the LP gets compensated however.
We do this right now as a new shop with limited balance sheet strength. We can't satisfy the bank liquidity requirements, so we get our LP to flash their balance sheet to appease the lender on non-recourse financing, and generate some more aggressive terms from relationship banks. The LP gets compensated for this risk via a fee, maybe an additional point on the value of the note. The fee is capitalized in the project cost basis and paid out via the loan proceeds.
Interesting way of doing this. So basically you show a sources and uses to the lender that’s a little higher and the fee is rolled up somewhere in the capital stack? Loan proceeds than go partly to the LP?
Interested to hear what book you are reading.
x2. i read investing in real estate private equity by sean cook and it was surprisingly good.
At my shop we would never take that kind of risk, that's why the promote is in place for the GP.
Happens all the time.
Usually you gotta pay for it though, say 0.5% that gets capitalized into the deal.
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