Real Estate Private Equity MarketsReal Estate Private Equity Markets

Structural Effects on NOIand Cash Flow

 

 

NOI (or Cash Flow)

Land owner (unsubordinated)

First mortgage

Second mortgage or Mezzanine financing

Equity (priority)

Equity (subordinated)

Land owner (subordinated)

   

 

Tranches--Slicing a Transaction into Components

Sources of Equity Financing

Owner/developer personal resources

Friends, family, and business associates

Third-party equity sources– High net worth individual investors– pension funds – Opportunity funds, mezzanine investors, hedge funds– Life insurance companies

Creative Sources– Land Owners. Contribute land in exchange for an interest in the

completed property– Land lease– Seller financing– Any other source with potential to gain from the transaction

Financial Structures Utilized to Own or Invest in Real Estate

“Free & Clear” or unlevered100% equity, without use of borrowed funds

Leveraged– Equity combined with borrowed funds

Hybrid – Combines equity, borrowed funds, and

mezzanine financingMezzanine financing may be structured as equity and/or debt

Unlevered Required Rates of Return for Various Real Estate Investment Strategies

Risk Free Rate Investment Rate U.S. 10-Year Treasury Bonds (6/09) 3.75%

Income Strategy Triple Net Leased Property *Investment Grade Credit

7.00% - 8.50%(+3.25% - 4.75%)

Core Strategy Fully leased, multi-tenant property 8.00% - 10.00%(+4.25% - 6.25%)

Value-Added Strategy Partially leased, below market rents, renovation

10.00% - 15.00%(+6.25% - 11.25%)

High-Yield Strategy Non-investment grade CMBS, Mezzanine Debt (up to 75% LTV)

13.00% - 18.00%(+9.25% - 14.25%)

Opportunistic Strategy Development, lease-up, non-performing loans

20.00% +(+16.25% - ???)

Joint Ventures(aka Partnership)

Sale and financing transactions are more “commodity-like” whereas joint ventures are individually negotiated and tailored transactions

A joint venture may be formed to:– Acquire a specific property, a portfolio of

properties, or an operating company– Recapitalize an existing partnership– Develop a property

Direct equity investments and/or equity joint ventures are available for

All product typesAll acquisition models-opportunistic, value creation, rehabilitation, yield, etc.Utilize third-party financing (70% to 80%)Term- 1 to 7 years

– Pre-defined exit strategy

Sources of Equity Financing

Structuring Joint Ventures

Each joint venture is idiosyncratic; there are no pre-set terms and conditions

Terms to be negotiated include:– Contributions– Preferred returns and “Claw-backs”– “Promotes”– Governance, guarantees (if any), fees and

transaction costs and expenses– Winding-up, Buy/Sell

Joint Venture Financing

One method public and private real estate operating companies (REOC) are increasingly using to access capital is joint ventures with institutional investors such as pension funds.Involve formation of new, special-purpose entity which is utilized to own the properties of the joint venture.Involve the contribution of existing properties owned by the REOC, acquisition of properties from a third-party, to-be-developed properties, or a combination of all three.

Joint Venture Financing

If the joint venture involves existing properties owned by the REOC, the REOC contributes the properties at an agreed upon acquisition value while the institutional investor contributes cash.

Profit sharing is based on the value of the equity contributed by the parties to the joint venture.

Joint Venture Financing

Under normal circumstances, the REOC receives an asset management for managing the joint venture as well as fees for property management and leasing the joint venture’s property.Joint ventures have a specified life or term, negotiated among the parties at the inception of the joint venture.Upon expiration, the properties are liquidated either through the sale of the properties to a third party, or acquired by one of the joint venture participants based upon a pre-negotiated formula or right of first refusal. The REOC may receive a disposition fee for selling the properties to a third party.

Private Real Estate Equity Capital Markets -Private Real Estate Equity Capital Markets -Range of Required Rates of ReturnRange of Required Rates of Return

Equity investor contributes up to 90% of capital Equity investor contributes up to 90% of capital required; real estate partner contributes balancerequired; real estate partner contributes balance

Real estate partner’s returns subordinated to equity Real estate partner’s returns subordinated to equity investor receipt of:investor receipt of: Current return of 4% to 8%, cash-on-cashCurrent return of 4% to 8%, cash-on-cash Cumulative return (look-back IRR) of 12% to Cumulative return (look-back IRR) of 12% to

16%16% Real estate partner handles day-today operations; Real estate partner handles day-today operations;

paid market rate fees (which increase return on paid market rate fees (which increase return on investment)investment)

Case StudyTerms of Acquisition JV

Structure: Limited Liability Company comprised of a subsidiary of the REOC (as managing member) and an affiliate of the institutional investor

Purpose: To acquire $250 million of industrial property

Invested Capital: Equity of $125 million, with 50% leverage; the institutional investor contributed 50% ($62.5 million); the REOC contributed 50% ($62.5 million)

Case StudyTerms of Acquisition JV

Leverage: 50% of the total acquisition price of the properties

Term: Minimum 6 years; maximum 8 years

Value-add Component: Improve property, create the value, and sell once stabilized to create Net Investment Income

Management: Major decisions (Sale, Finance, Liquidation, Management Change) require both partners concurrence. Day to day operations and management handled by REOC.

Case Study Terms of Acquisition JV

Fees: The REOC will receive an disposition fee equal to 1% of the sales price, management fees and leasing commissions at market rates, and an asset management fee equal to 0.5% of the value of the joint venture properties.

Case Study Acquisition JV Waterfall Distribution

First, to repay capital contributions made by each partner (typically 50%/50%)

Second, to pay each partner a 10% cumulative annual return on capital

Third, 35% to Institution and 65% to REOC

Projected Leveraged return was 11% for Institution and approximately 13% for REOC.

Case Study Terms of Development JV

Structure: Individual Limited Liability Company comprised of a subsidiary of the REOC and an affiliate of the institutional investor

Purpose: To develop $300+ million of multi-family property

Invested Capital: Equity of $100 million, with 70% leverage; the Institutional Investor contributes 85% ($85 million); the Developer contributes 15% ($15 million)

Case Study Terms of Development JV

Leverage: 70% of the development cost

Term: Develop, Stabilize, Sell (typically 3 yrs)

Management: Major decisions (Sale, Finance, Liquidation, Management Change) require both partners concurrence. Day to day development operations and management handled by REOC.

Case Study Terms of Development JV

Fees: Developer receives a GC fee of 5% of hard costs, development fee of 3% of total costs, and a management fee of 3% of gross revenues

Cost Overruns: Cost overruns offset by Developer’s fees, then 85% Institutional Investor and 15% Developer

Case Study Development JV Waterfall Distribution

First, to repay capital contributions made by each partner (typically 85%/15%)

Second, to pay each partner a 10% cumulative annual return on capital

Remaining proceeds split 60% to Institutional Investor and 40% to Developer

Target IRR 18% to Institutional Investor

Typical Waterfall Distribution

Current Environment: The capital partner has more leverage. This means that the hurdle rates may be higher, the promotes for the LP may be lower and/or fees may be reduced to the operating partner. In certain cases all 3 of these things have occurred.

Cash Flow Distributions

Current Current Yield Yield AchievedAchieved

InvestorInvestor REOCREOC

Up to a 15% Up to a 15% cumulative annual cumulative annual yieldyield

80%80% 20%20%

Up to a 20% Up to a 20% cumulative annual cumulative annual yieldyield

65%65% 35%35%

ThereafterThereafter 50%50% 50%50%

Proceeds of Sale

IRR IRR AchievedAchieved

InvestorInvestor REOCREOC

Up to a 15% IRRUp to a 15% IRR 80%80% 20%20%

Up to a 20% IRRUp to a 20% IRR 65%65% 35%35%

Above 20% IRRAbove 20% IRR 50%50% 50%50%