Convertible Equity in Development - Making the LTC Work
Hey guys- question on some creative financing options to achieve necessary equity requirements without diluting long-term ownership.
Has anyone seen a scenario where the developer, in order to maintain long-term ownership, has brought on a "convertible equity" partner? Idea being, equity partner acts as straight-up equity with pari passu distributions during the construction loan term, which then converts to debt upon takeout financing, thereby allowing the developer to buy out the equity partner at an agreed-upon preferred return.
If not, has anyone seen structures that you think might be applicable here?
TLDR; has anyone seen an inverse of preferred equity in practice? If not, other options?
what distributions during the construction period? You mean the take out loan?
I would think pref equity or mezz would work better in this scenario. Unless you really need that last 10% gap equity at 85%-95% of the capital stack.
How i read it. I'm going to have the most risk in construction where I am subordinate to all debt vehicles, then once that risk is over, I'm going to the safest place in the capital stack and not be compensated for the risk?
Convertible debt works the other way, debt first with right to convert to equity
Maybe I'm not understsanding what you are asking
Distributions while the construction loan is still in place, post grand-opening pre take out loan.
Can't use mezz or pref eq in this scenario because of how the bank is looking at this deal.
Correct. Subordinate to the first position debt but senior to the developer equity. Then receive distributions during construction loan term after the project is cash flowing but have not closed the take out loan. Upon close and fund of take out loan, buy out this "middle" equity position at a pre determined pref return.
This is essentially the complete opposite of convertible debt. Someone who isn't highly risk averse but does not want to have a long time horizon on the investment.
Usually all payments before distribution to equity go to the senior lender, then the mezz, then the pref, then the common(pref return), then sponsor.
How is the bank looking at this deal? Some banks do senior and the mezz, like Mack Credit. Why does the bank care what equity is used if their LTV/LTC threshold is met?
Do you want this equity piece to accrue, is there a current pay too? You realize they will just be paying themselves out of capitalized interest.
Yeah i got that. That literally sounds like a perfect fit for pref equity.
Why not go debt fund...I'm sure you can find a bank/fund that will lend up to 85%LTC, but it will cost you.
I still don't get this deal. Not in a negative way,just not sure why you cant use pref equity?
I have the same question myself, it doesn't make any sense as to why they care at all as long as there's a cash contribution.
I completely agree. Will have to take a look again at debt funds for this.
I am with you on that. I can't get super detailed for obvious reasons but it doesn't make sense to me either.
Thanks for your insight on this, appreciated.
I've seen a model where all of the equity upfront is put up by the JV and is structured as low cost pref (like cheap debt). Once a certain return threshold is broken, the developer is granted a 25% stake in the deal and returns are split pari-pasu in a long term hold.
What you're suggesting seems like a catch up in a waterfall distribution right?
In the scenario I am suggesting, the second equity position is a short term position with a pref return kicker on the funding of takeout loan. The stabilized financing here would take out both the construction loan and the equity partner.
I have no idea if this is even feasible, hence my asking.
I've never seen your proposed structure done and don't understand what the upside is for the JV partner.
The structure that I've mentioned above is one that a family office uses in order to diversify their long-term investments without having to hire an asset management staff. Effectively it is like paying a value-add promote and asset management fees into perpetuity without incentivising the developer into disposition.
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