Risk Mitigation in the Capital Stack

As most of us are not HNW, what are some ways that you can use the capital markets to mitigate risk. As an example, while 65% LTV is not as risky as an 80% LTV loan, but you still have to put up a lot of cash especially for anyone not a mogul(see other thread).

Using Pref Equity you can farm out some of the equity capital stack and put up less money. Now the downside is that it increases your leverage with expensive equity, which can accrue to a sale/refi if not cash flowing in a downturn. But the upside is that with acquisition fees of 2%, debt fee of .5% and AM fee of 1% and management fee of 5% of revenue, you have enough to keep the lights on and depending on the cap rate, you see return of capital after the 3-4 year mark. From there on in, it is like you are playing with house money.

How much safer would it be to get a loan at 65% LTV in this scenario rather than 80%, given the cost of capital right now is so much higher for equity than debt.

Does anyone else have any other clever way to "game" the system, and in this scenario I'm talking about cash flowing properties with a high cap rate in the 6%-7% range. which can throw off enough money to pay pref equity.

Should one just go I/O on a 6% cap BK and leverage up to the hilt.

Comments (4)

Most Helpful
Mar 12, 2020

You may want to consider some form of hybrid convertible debt and/or a form of an equity participation mortgage. Some HNW lenders and even debt funds are doing stuff like this, even some large funds for development deals.

Generally, in exchange for the "equity kicker" part, you get lower interest, higher LTV, and even default mitigation (i.e. un-paid interest added to back, probably at penalty rate). With the convertible, if things go bad, it becomes equity (will eat your lunch), but still better than foreclosure.

    • 2
Mar 12, 2020

Exactly, what I am talking about, but in a great debt structure. Do you know any funds of office's doing this?

Mar 12, 2020

Not off-hand, Ambit Funding used to do this back before the '08 crisis, I did a few deals with them in prior I-banking life. UBS had an institutional fund doing this with large developer borrowers (participation mortgages). I would check with some active debt/equity broker types, they usually know who is active. I'm too far removed from this to know who the players are today.

Mar 24, 2020