Frustrated by disapproval of a conventional bank loan? Annoyed by the lack of creative financing options for your commercial real estate investments? Real estate developers and investors should consider the benefits gained from alternate real estate financing options before pursing their next development.
While traditional mortgages remain the most common financing option for commercial real estate projects, developers and investors have started to rely on alternative financing options to either supplement or altogether replace traditional financing options. When pursuing your next commercial real estate project, you may want to consider one of the following alternative options:
Installment Land Sales Contracts. An installment land sales contract is an agreement between the purchaser and seller of real estate that obligates the parties involved financially over a period of time but does not involve the transferring of a deed for the property. The purchaser pays the purchase price in periodic installments, and when complete, title passes from seller to purchaser.
Mezzanine Loans. In its most common form, a mezzanine loan is a form of subordinate debt that is secured by the investment property, but only indirectly, by a pledge of the equity in the entity that owns the property rather than on the real property itself. Developers and investors generally seek mezzanine financing to acquire real property using mezzanine loan proceeds in place of the purchaser’s own equity, particularly if the mortgage lender prohibits subordinate mortgage financing or to refinance a specific project costing more than the proceeds the mortgage loan will provide. Mezzanine investors thus take on more risk like equity investors but typically have contractually mandated monthly or quarterly interest payments that are higher than traditional lenders.
Preferred Equity Investments. Mezzanine debt and preferred equity both serve primarily to increase total leverage for a real estate investment above what a senior lender is willing to provide. In contrast to mezzanine loans that are made under a borrower/lender relationship, preferred equity investments usually take the form of a direct equity investment in the property owner, with a preferential return that is paid prior to distributions to common equity investors. The necessary legal agreements also vary between the two forms of financing, with mezzanine lenders typically entering into an intercreditor agreement with the senior lender in addition to their agreement with the common equity partner. Preferred equity will generally only execute an agreement with the common equity partner and, with no lien against the real property, is generally subordinate to both the senior lender and the mezzanine lender.
Sale Leaseback Agreements. A sales leaseback agreement constitutes an arrangement where the seller of an asset leases back the same asset from the purchaser. The lease agreement is made immediately post-sale. A sales leaseback agreement is useful to untie cash funds invested in real property, but also allow for the continued use and operation of such real property.
ICOS. A house on blockchain? Initial coin offerings (ICOs) might not just be used in the corporate setting anymore to raise funds for new business ventures. Recently, some real estate developers and investors have envisioned using ICOs to raise funds for commercial real estate projects. Blockchain can allow the securitization of a project over a longer period of time and for a fraction of the cost of traditional financing options. It can also bring new investors into the market by permitting small investment amounts. However, before ICOs become commonplace for commercial real estate projects, significant legal hurdles will need to be worked out. The laws regarding real estate in the United States are very complex and vary from state to state and county to county, making uniform adoption of real estate ICOs difficult.
Alternative financing options, like the ones described in this article, give the parties to a real estate transaction additional flexibility in negotiating creative financing terms that traditional mortgages do not and cannot offer. This also benefits lenders, which can compete in the growing real estate market with creative new financing options that will attract commercial developers. Such loans can, however, be riskier as they are not subject to the same laws and regulations that traditional mortgages are subject to. The attorneys at Fauver, Large, Archbald & Spray, LLP have the expertise and knowledge to find creative solutions and alternatives to traditional financing options. Please do not hesitate to contact me or the BFAS attorney with whom you regularly work with any questions.
DISCLAIMER: This Advisor is one of a series of business, real estate, employment, estate planning and tax bulletins prepared by the attorneys at Fauver, Large, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution or use of this Advisor.
