Dear Fellow Monkeys,
I'm evaluating an office acquisition deal and trying to get an understanding if this fits industry standards. The family office I work for is far from sophisticated. The property is a multi-tenant office building with 88% in place occupancy and we're in GP. Assuming market and leasing assumptions are reasonable, unlevered IRR is about 7.75%. The capital stack for a 10-year hold is as follows:
- 70% funded by senior bank loan (3 months I/O, amortized over 30 years)
- 18% funded by mezz loan with accelerated amort over the first 3 years, then amort over the rest 7 years with equity kicker (its proportionate share of 75% profit split in the last tier of waterfall)
- 2% funded by GP and 10% funded by LP
Waterfall:
- 8% return CoC to LP and GP contributed capital; any excess cash after 8% cash on cash will be used to pay down mezz principal in the first 3 years
- Then keep returning cash till 10% IRR hurdle
- Thereafter, 75/25 profit Split where 75% goes pro rata to LP, GP, and Mezz and 25% goes to GP
Thoughts?
Hey ChinaBankingMonkey, the following topics might be helpful:
If those topics were completely useless, don't blame me, blame my programmers...
Honestly, groups that are "far from sophisticated" should shy away from the mezzanine sharks.
What's the rate on the mezzanine loan?
They’re charging 10%. Wonder what would be the thought process of staying away from these mezz lenders? I do get a feeling that they’re rewarded too much and being returned principal too quickly with very limited exposure to exit risk.
(a) taking on that much leverage leaves far less room for error and (b) your point hits the nail on the head, there shouldn't be any accelerated amortization nor should there be a 75% kicker, that's absurd they are getting the best of both worlds. 10-12% with normal amortization and no kicker is market for most mezzanine debt right now...
the folks that had mezz in their capital stack got caught with their pants down during 2008/2009.
what kind of return is your group projecting for youself? if you build a sensitivity in your model, you will see a slight pullback in rents screws up your return. i would love to be the mezz piece if your group is not sophisticated! what's the worse that can happen? your group f**ks up due to a mini recession out of your control and the mezz group gets in the drivers sit? hhmmm ...
Exactly if the mezz lender is willing to deal with an unsophisticated owner they are more than willing to loan-to-own the deal...
The mezz piece doesn't make any sense. Every mezz loan I've looked at is interest-only. Additionally 75% profit split is ridiculous- there is no meat left on the bone for the equity. The LP will never be ok giving up the much profit / upside. When you add in the rapid amortization, 10% rate and backend kicker the cost of capital for the mezz position is too high
Thanks for the insights everyone! We just killed the deal. To make it even less desirable, there are only about 12 years left on major leases, tenants having the option to renew at only 2% increase ... no upside for the landlord and very hard to sell or refi at exit
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