This question sorta ties into a previous post regarding challenges becoming a sponsor. One of the biggest factors I think is having a balance sheet available, in order to secure debt financing. Given the capital flows currently, competitive debt quotes aren't too much of an issue, with interest only available at competitive rates and LTVs.
In a typical JV scenario, the LP investor(s) want to the GP to sign on the carveouts. Despite the fact that you can get non recourse debt for existing property acquisitions, there are still certain hurdles, such as net worth and liquidity that need to be met. A first time sponsor likely will not have the individual ability to sign on the loan, so I imagine either they would need the LP to do so, or have a partner on the GP side who has the ability to sign on the loan.
Just curious to get feedback on this topic, any opinion on ways to make this scenario work efficiently, etc. Thanks.
There are some lenders that will accept the borrower as the guarantor for the carve-outs and then you solve the environmental by buying insurance. However, this usually isn't open to a new sponsor unless one of your LPs is known or they have a property the lender really loves.
The above is what I've seen save a fair amount of new sponsors where I work (life co). They had institutional capital as their LP, so we accepted the borrower on the carve-outs as long as the ownership structure didn't change. Otherwise, the sponsor would have never qualified for our normal net worth/liquidity requirements.
Otherwise, you will probably need to have an LP sign joint and several on the carve-outs/indemnity until you have the ability to do it yourself (this really isn't that uncommon even among large sponsors). One thing to be careful about is that most lenders will limit the number of guarantors in a deal (usually to two or three) because they don't want to have to sue a million people to recover money if something goes wrong. If you have say 20 individuals that pool $ together into your deal, you are going to have to funnel everyone down into one or two entities somewhere above your borrower so that by the time you get to your borrower, they are big enough to matter.
"Otherwise, you will probably need to have an LP sign joint and several on the carve-outs/indemnity until you have the ability to do it yourself (this really isn't that uncommon even among large sponsors)."
But LP's are alright with that? Isn't the LP in on the investment solely to ride the GP to target IRR then their share of the left overs after the promote? The very nature of "Limited Partners" is the "Limited" feature---non-recourse investment that they can't get sued on. That's what makes an LLC special.
LPs do mainly want their IRR on a non-recourse basis, but that IRR is usually a figment of the imagination without leverage.
Really though, non-recourse carve outs are pretty damn easy to comply with (and totally in the control of the borrowers). Sometimes deals go bad, that is built into the system, but act with some decency and within the law; if you work with your lender instead of against them, then you shouldn't ever have reason to perform on that guaranty.
And again, negotiate to buy insurance on the environmental (because tenants).
Thanks guys, the actual non recourse carveouts themselves I agree, not a major issue.
I guess my focus was more on borrower ability to meet liquidity and net worth covenants. In the classic case of the investor who brings the deal and the management ability, but lacks the capital required to transact. Is it possible to bring in an equity partner for effectively 99%+ of the equity and then ask them to put their balance sheet up to meet the liquidity and net worth requirements?
Yes. That's what we do, at least. Your problem as a sponsor will be finding the person who believes in you and your deal enough to put their own ass on the line. I'd guess that special someone will expect to be appropriately compensated for the risk.
"Your problem as a sponsor will be finding the person who believes in you and your deal enough to put their own ass on the line."
As explained above, they really aren't putting their ass on the line. Unless there is risk that the sponsor does something unethical or does not comply with the borrower, then the guarantee wont ever come to fruition and the LP is never truly risking their balance sheet.
Yes, totally possible.
I've never been a first time sponsor myself (I've always worked at established firms/my own stuff is all residential so this hasn't been a concern yet), but I kind of feel like if you can get to the point where you have gotten a commitment of money from someone, then having them sign onto a guaranty/indemnity should be a fairly easy sell.
And as I said before, a lot of true first time sponsors I've worked with had institutional partners in the structure, so we waived requirements as long as their institutional partner stayed in the deal (if JPM Strategic or USAA are your 80% LPs, we feel pretty good as a lender).
Look into a collapsible TIC structure. Some lenders will refuse to even talk to you with this structure in place, but others don't care. This structure usually has a controlling TIC (You), makes everyone else a separate owner, and then has everyone sign documents joint and several. Sort of crazy from a paperwork standpoint, and the lenders who accept them usually limit the number of TICs, but sort of interesting way to do it as well. You see them mostly in multifamily world but last year I worked on two big NYC office deals that used them.
What about relatively low leverage deals? I'd think if you're doing, say, 50% loan-to-cost in a reasonably decent area most lenders would be ok with granting non-recourse deals. You may not be achieving "alpha" but you're also reducing the risk level of your equity investors by reducing leverage, which may not require the highest possible project IRR.
You could probably find a regional bank or get a loan from a smaller life company (there are a few that specialize in sub $10 million loans) for something low leverage if you were a new sponsor.
CMBS can't do it because they probably wouldn't be able to securitize. Bigger life companies usually take borrowers only on deals with known/verified sponsors.
GSE loans are non-recourse and can close in a timely manner. Fannie and Freddie have somewhat recently rolled our their small loan program if the loan amount you are looking for fits into that bucket. You have to put up with the headache that is working with GSE's, but they will get you money in a reasonable time frame if you don't mind playing by their rules. You can also have "silent partners" sign off as a guarantor so long as they stay in the deal in some way shape or form. I have seen a lot of people get pretty creative with their guaranty structure on GSE loans. That all depends on the who is servicing the loan so your mileage may vary.
I haven't done it as a one-off sponsor where we needed to get someone else to sign the guarantee or carveouts for over 10 years so maybe things are different now but when we needed a balance sheet to sign we'd give that entity (or UHNW) a signing kicker in the form of some pref in the waterfall higher than equity and lower than external debt (kind of like a jr., jr. mezz, but without having to invest any extra capital) and/or out of the GP (or both depending on the makeup of the LP/GP). It could have been an LP or sometimes someone outside of the LP's. So that entity does get paid for it. The actual structure of it is completely dependent on the lender but they at least used to work with you on it.
I know a few guys who around 12 years ago started up their own shop and had institutional equity that wasn't necessarily willing to sign for debt (or at least it was easier and quicker for them to get the equity without having to deal with guarantors) so they formed their management co/GP and raised a small chunk of operational money from a big time developer (he sold to a public REIT and walked away with something like $2B-you've probably shopped in his malls if you live in the northeast) who agreed to sign for any guarantees. They didn't necessarily need the operational money and had to give up a decent amount of the management co to him, but being able to have any debt guarantor issues taken care of and having the guy's name attached gave them the ability to move quickly and win deals. They're now a $2B market cap REIT.
If a closed ended fund is putting in the equity, aren't they typically putting the fund's balance sheet up to secure debt? Liquidity and Net Worth is covered this way, correct?
A guaranty is designed to give a lender collateral other than the property itself. So in situations where the lender accepts the borrower as the guarantor, or where (as egold70 suggests) the only equity backing the loan is the equity in the property itself, there really is no guarantee of the loan obligations other than the lender's security interest in the property.
In most non-recourse loans (though admittedly not all) lenders will require "non-recourse carve-outs." These carve-outs are generally NOT designed to "secure the debt" and should not allow the lender to go after the guarantor for repayment simply because the property declined in value or stopped generating cash flow to cover debt service.
Instead, non-recourse carve-outs (also often known as "bad-boy" carve-outs) are designed to instill some "behavioral modification" of the borrower and the owners who control it. The biggest issue lenders are trying to address with the carve-outs is typically bankruptcy risk. If a borrower can no longer pay its mortgage or satisfy the terms of the loan, the "good-boy" behavior is to either work out a deal with the lender or, if a satisfactory deal cannot be reached, simply deed the property to the lender or surrender it in a non-judicial foreclosure. It's a relatively simple process for a lender to obtain the collateral, which is why lenders like real property as collateral. However, a "bad-boy" borrower can file a bankruptcy action, which puts a stay on a lender's right to exercise foreclosure. This can result in the borrower dragging the lender through timely and costly litigation for a protracted timeframe, and sometimes a bankruptcy court will impose undesirable restructuring provisions on the lender. To prevent this, lenders in non-recourse loans will generally demand full-springing recourse to a parent entity in the event a bankruptcy is filed.
Carve-out items are typically bifurcated between "loss items" (items for which the lender can pursue the guarantor for provable losses) and "full-recourse" items (which allow the lender to pursue the guarantor for the entire loan amount plus other damages). Loss items often include items like misappropriation or misapplication of cash flows, intentional waste of the property, etc. Full-recourse items are usually items that undermine the lender's access to the collateral itself (like bankruptcy, violation of the SPE requirements, non-permitted transfers of the property, etc.).
One final note: "limited" partners in joint venture deals these days aren't so limited. From what I've typically seen, the pension funds, endowments, and other institutional investors that invest as "limited partnrs" in commingled real estate funds are typically true limited partners with little discretion over the actions of the funds. But when funds invest 95%+ of the equity alongside local operating partners in joint ventured real estate deals, the funds will typically be limited partners in name, but will generally control all major decisions in the venture and exercise a fairly significant degree of control. I think it's pretty shocking that many operators are willing to sign non-recourse carve-outs where the fund partner controls most of the decisions that would trigger recourse.
So the partnership agreements in the 95/5 LP funded equity deals that you've seen have provisions saying the LP gets final say with everything related to the deal?
What's the point of pooling the LP's money with the GP then? Why give the GP the promote and credit of being the owner operator? Why not go in at 100% of the equity and get all the promotes, credit and etc. It's the LP's balance sheet after all. Not enough man power or concentrated focus, perhaps?
I would wager this is the main reason. Some funds can invest as LP, or do the deal as 100% equity. Typically LP wants to partner with a sharpshooter operator that has specific geographic focus, product type focus, etc. Let's face it, most larger LP funds are located in markets like New York, so buying a deal in, say, Oklahoma City, unless it's core Class A, will require someone active in that market as an operating partner.
Yes. Most 95/5 deals I have seen give the 95% "capital" partner final say on major decisions (budget approval, sale, financing, leasing, etc.). The 5% "operating" partner is usually tasked with managing the property on a day-to-day basis, and brings important matters to the capital partner for approval.
5% of the equity is such a tiny sliver for the capital partner putting in 95%. Capital partners don't ask operators to put in that money because they think it's a meaningful piece of the deal and shares the exposure. Capital partners demand 5% (sometimes more, sometimes less) because they see 5% as a meaningful piece of the operator's net worth, and thus will ensure the operator faces real downside exposure in the deal rather than just one-sided upside from the promote.
Capital partners reward operators for their management and operating expertise, but you are right, many funds today have the in-house ability to self manage deals or higher a fee-based manager. The real reason to give carried interest to an operator is if they are able to generate off-market or proprietary access to deals.
Sint fuga inventore eum nam saepe consequatur nihil. Minima labore ea qui. Provident corrupti minima veniam aspernatur. Excepturi omnis tempore quia corrupti aut expedita ducimus.
Blanditiis mollitia iure aut repellat sunt sequi. Quod explicabo ut dolore et nobis. Perspiciatis excepturi natus aut saepe nesciunt quia autem. Incidunt et aspernatur culpa molestias vero.
Id ut eveniet accusamus. Pariatur omnis quia veniam voluptatem. Quibusdam cumque itaque aliquid sint. Et voluptas doloremque non.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...