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Equity Lending: Big Purse, Tight strings

If you are looking for equity, now may not be the best time to do it. "It's low on the priority list right now. (Capital sources) want regular loans first because it's their bread and butter," says Jeff Johnson, executive vice president of Kansas City, Mo.-based Midland Loan Services.

It's not exactly that equity is unavailable. In fact, according to Gary Mozer, a senior vice president with Los Angeles-based George Smith & Partners, funds are more than ample.

Rather, not much is being given out. And of what is being distributed, there are few enough sources that they feel free to pick and choose the best prospects without having to make sweetheart deals.

Many observers expect the number of sources to rise early in the year as lenders regain composure after the jitters caused by the late summer CMBS meltdown, but few believe conditions will match those of a year ago.

Unfortunately, developers have more need of equity partners now that loan-to-value ratios for permanent loans have dropped. According to Michael Surber, president and CEO of USA Funding Inc., a lender and mortgage broker in Carmel, Ind., many borrowers that had been able to come up with 15% to 20% of project cost cannot manage 5% to 10% more without additional help.

The keys to success right now, Mozer emphasizes, are high return and low risk.

"If you have a to-be-built supermarket-anchored center that is 80% preleased, people will throw money at you," he says. "The same goes for a regional mall with committed anchors and 60% preleasing on shop space."

On the other hand, without signed anchors and a high level of preleased shop space, you will have to do the throwing and pray someone catches. And if they catch, go in with lowered expectations.

According to Mozer, the rule of thumb is 200 basis points between the stable cap rate, which is defined as the stable net operating income divided by project cost, and the exit cap rate. That is, if you start with an 11% cap rate, you need to be able to sell at 9%.

Sources for equity are numerous, according to various industry insiders. Among them are hedge funds, investment banks, credit companies, pension funds, some banks, high-net worthers and some REITs. Surber reports that his firm has 600 to 700 funding and joint-venture partnering sources in its database. However, he adds, a borrower has to be open to creative solutions to make a deal work.

According to Lawrence Bond, managing director of the Summit Fund in Los Angeles, Summit is actively looking for retail opportunities - as well as new relationships.

"We often joint-venture with people who are not established," he says. "Usually they've worked for larger (development or investment) companies and are just going off on their own. They're more reliable because they can't afford not to have a home run."

The big question for the industry concerns the REITs. Though most REITs withdrew from the market in the fall (not entirely by choice), some are back and cautiously seeking joint-venture opportunities. For example, Lewis Sandler, president and CEO of Dallas-based United Investors Realty Trust, reports his firm initiated some joint-venture deals in December, following three months of inactivity. The projects are small, in the $5 million to $7 million range, and all have solid commitments from credit tenants.

REITs have found their own sources of equity, as it were, other than stock sales. Diversified, for example, received a $238 million infusion from DRA Advisors via a joint-venture agreement. The arrangement allows the REIT to do off-balance-sheet development and acquisition. Of course, only the strongest REITs are candidates for such transactions.

The thorniest issue with equity funding, says Mozer, is control. Equity investors demand a higher percentage of ownership and greater say-so in what happens than in the past. They also want a higher contribution from the developer or buyer.

According to Michael Tobin, managing director of development for Chicago-based Kaplan Group, a developer generally needs to come up with 10% to 15% of the total cost to get most deals done. To get more than that, the developer will need to give up a hefty share of ownership or pay a steep rate.

An investor that provides 80% of the equity is likely to demand 60% to 70% of the proceeds. As Mozer remarks, "The days of the 50-50 split are over unless you're Simon or General Growth."

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