Retail Tenants in Mixed-Use and Lifestyle Developments: An Underwriting Paradox

By: Brandon Wilhite With the resurgence in interest in living in denser, urban walkable environments, development patterns across the country are shifting from single-use developments, Read more

The IRR Waterfall: Splitting Real Estate Profits - Lenders, Investors, and Developers

How can equity investors in commercial real estate transactions shield themselves from downside risk, provide enough incentive for the development partner, manage the upside, Read more

How to Turn a Dud into a Stud: Using Legislation to Reduce the Liability and Costs Associated With Groundwater Contamination

By Duke Dennis What do parties to a real estate transaction think when they hear that the property acquisition they have been working on has Read more

Mile High City’s Industrial Real Estate Hits New “High”

By Charley Babb The vacancy rate for commercial real estate industrial space in Denver is hovering at just over 4%, which is a historically low Read more

How Can MCA Make You a Better Sales Broker?

Here at Metropolitan Capital Advisors, we get asked all the time by our clients if we broker the sale of commercial property. The answer Read more

The Shifting Landscape of CMBS Power

By Todd McNeill The balance of power is moving around the CMBS playing field in 2015, and loan originators seem to find themselves with the Read more

Commercial Real Estate Capital Markets Are Liquid; Development Accelerates during 2014

By: Scott Lynn The recovery of the commercial real estate capital markets has gone full cycle since the depths of the Great Recession in 2008.  Read more

Borrowers Are Not A Commodity

By Kevan McCormack Commercial Real Estate development by all accounts is a simple business concept (over simplified below): 1)    Find a Location; 2)    Design a Building; 3)    Secure Read more

Metropolitan Capital Advisors Arranges $5,375,000 Equity JV & Interim Construction Financing For A Retail Shopping Center in Huntsville, Texas

DALLAS, DECEMBER 2014 — Dallas, Texas-based Metropolitan Capital Advisors (MCA), a financial intermediary specializing in the exclusive representation of investors, developers and property owners Read more

Is Blackstone Calling the Top Again?

by Charley Babb Blackstone Group, the private equity giant, appears to be revisiting its pre-recession game plan of acquiring undervalued real estate assets and then Read more

Commercial Real Estate Investments and Phantom Income: More Than You Bargained For

By Brandon Wilhite Any prudent commercial real estate investor will take into consideration the tax implications as an important part of his or her investment Read more

Is Now the Right Time to Invest in Real Estate?

By: Justin Laub I recently sat down with a friend in the oil and gas industry who asked me, “Is it a good time to Read more

The Non-Basic Food Groups in Commercial Real Estate

By Sunny Sajnani As a real estate professional, we always hear about the four basic food groups of commercial real estate: multi-family, office, retail and Read more

Off-Market or Selectively Marketed in CRE Deals

by Hook Harmeling As we emerged from the Great Recession, there were “deals” everywhere. Excellent locations, quality buildings, good tenants and, yes, even good sponsors Read more

Paradigm Shift or Lack of Financing in the Red-Hot Apartment Demand Surge?

By Todd McNeill While perusing recent press on the strength of the market for new apartment developments, the following thought occurred to me:  Is the Read more

Metropolitan Capital Advisors Arranges $5,800,000 Land Loan and Subdivision Development Financing for Prestonwood Polo Club in Oak Point, Texas

Dallas, November 2014 – Dallas-based Metropolitan Capital Advisors (MCA), a financial intermediary specializing in the exclusive representation of investors, developers and property owners in Read more

Could Downtown Apartment Development Max Out in North Texas and Other Major Markets?

As featured in the November Newsletter from Bisnow.com There are 9,000 multifamily units in the pipeline in Downtown and Uptown, but skyrocketing land prices, rising Read more

Metropolitan Capital Advisors Closes A $10,950,000 Permanent Fixed Rate Mortgage For A Retail Shopping Center In Greeley, Colorado

Dallas, Texas-based Metropolitan Capital Advisors (MCA), a financial intermediary specializing in the exclusive representation of investors, developers and property owners in the commercial real Read more

Metropolitan Capital Advisors Exhibiting at International Council of Shopping Centers Texas Conference, Nov. 12 - 14, Booth 771

See the Metropolitan Capital Advisors Team at Booth #771If you are in the commercial real estate industry, you've most likely heard of or attended Read more

The Urban Renter: Who Art Thou?

By: Scott Lynn One trip down the tollway to Uptown/Downtown Dallas leaves me in utter amazement at the amount and quality of high-density multifamily projects Read more

Development Is As Hot As the Texas Heat

By Gabe Gonzalez It seems like construction cranes are part of everyone’s skyline these days.  Even secondary markets such as Waco, Lubbock, and El Paso Read more

The Local Bank vs. CMBS Boxing Match, Special Texas Edition

By Justin Laub             On one side of the ring we have your Local Banker from Texas. He’s wearing a polo shirt from the country club Read more

Metropolitan Capital Advisors Closes $5,560,000 Construction Loan For Speculative Industrial Project In Oklahoma City, OK

Dallas, Texas-based Metropolitan Capital Advisors (MCA), a financial intermediary specializing in the exclusive representation of investors, developers, and property owners in the commercial real Read more

Thank the FDIC, OCC, and FINRA for Residential Increases Bringing CRE With it!

by Todd McNeill The rebound in home prices in the Dallas / Ft. Worth residential market has been record-setting during the last three years.  I Read more

MCA Closes Two Single-Tenant Government Office Loans Totaling $19,900,000 in Oklahoma

Metropolitan Capital Advisors, Ltd. (MCA) has closed long-term debt financing for two separate office buildings leased to government service tenants. Lincoln Plaza, a 154,085 SF Read more

Retail Tenants in Mixed-Use and Lifestyle Developments: An Underwriting Paradox

Retail Tenants in Mixed-Use

By: Brandon Wilhite

With the resurgence in interest in living in denser, urban walkable environments, development patterns across the country are shifting from single-use developments, such as a retail power center or an office park, to mixed-use developments consisting of retail, residential, office and restaurants. This trend is fueled by both younger and older generations alike.  Young Millennials have no desire to spend significant portions of their days in their car and want to live in close proximity to both their place of work and their favorite neighborhood hotspots.  Likewise, empty nesters are finding themselves no longer wanting to maintain their 3 or 4 bedroom houses now that their adult children have moved out and want to downsize, ridding themselves of the burden of maintaining a pool or yard.

A large part of the appeal of urban living is the proximity to the lifestyle and leisure, such as restaurants, coffee shops, bookstores or gyms. Urban dwellers are particularly drawn to new, unique and innovative businesses that are often independently owned. A restaurant owned and operated by a local chef is generally more likely to be patronized than a generic national chain restaurant. But, therein lies the problem…

Lenders and investors often focus on the credit of tenants when underwriting commercial real estate.  The stronger the credit of the tenant(s), the lesser the likelihood that they will default on their lease payments, thereby reducing the risk to both investors and lenders. However, focusing on credit in an urban mixed-use development can create an interesting paradox.  The local restaurant owner may not necessarily have bad credit, but his balance sheet is often not sufficient for a lender who is underwriting a loan whose debt service will be paid by that tenant’s rental income. This is less of a problem in a refinance or acquisition when a lender can look to the historical performance of a property and its tenants. However, when underwriting a new development, a lender won’t have that luxury.

Our team at Metropolitan Capital (“MCA”) has quite a lot of experience in working through this issue for our clients.  Here are a few strategies we have found to be helpful in getting lenders comfortable with these types of tenants:

  • Sell your tenant’s background and resume. If your tenants have a proven track record of success, this can go a long way. Is their business a proven concept or a new one? How many other businesses have they started, and how have they performed?
  • Sell your tenant’s concept and why it will be well-received in the development’s location. If kebabs are the hot new trend and your tenant has a quick-serve kebab concept to serve the neighborhood workforce population who have previously had to drive 5 or 10 minutes to get their kebab fix, then that is a compelling recipe for success and should be emphasized!
  • Sell the depth of the market. Tenants’ going out of business is unfortunately a fact of life. However, urban developments or redevelopments can typically be found in supply-constrained markets, which can often mean that space can be very quickly leased to any of a number of tenants who have been waiting for an opportunity to find space in that market. A highly coveted market is a huge risk deterrent.

If all else fails, it may be time to consider some financing options in order to get your deal done, which may be less attractive initially but will still allow you to execute your business plan. One option may be to de-lever down in the 50% to 60% Loan-to-Cost range in order to get the lender comfortable with the risk.  At lower leverage, a tenant default is less likely to negatively affect the borrower’s ability to service their debt.

Another option may be a private (non FDIC-insured) lender.  A private lender can often get you to your desired loan proceeds, albeit at a higher interest rate. Depending on the borrower’s confidence in their tenants, this may option may enhance risk, as a tenant default is more likely to negatively affect the borrower’s ability to service the debt at a higher interest rate.

While the above options may be less attractive initially, they are often an effective temporary strategy to get your development financed and to get your tenants in occupancy.  Once the development has been built and your tenants have established successful track records, you will have an easier path to obtaining traditional bank financing.

Obtaining financing for what many banks consider to be “non-traditional” developments can often be tricky. MCA’s experience can prove to be invaluable in assisting borrowers to navigate through this process. For further information on how Metropolitan Advisors can help you finance your next mixed-use development, please contact Brandon Wilhite at bwilhite@metcapital.com or visit our website at www.metcapital.com.

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The IRR Waterfall: Splitting Real Estate Profits – Lenders, Investors, and Developers

How can equity investors in commercial real estate transactions shield themselves from downside risk, provide enough incentive for the development partner, manage the upside, and still maximize equity returns?

The Internal Rate of Return (“IRR”) Waterfall structure is a methodology by which the equity partner can accomplish these objectives.

First, let’s establish the key players to a real estate development transaction and evaluate their risk profile:

IRR waterfall image 1

 

Lenders, with first payment priority, accept a predetermined return, namely, the interest rate on their provided debt capital. Next, the Equity Investor invests capital that is subject to the success of the project. Finally, the Developers (who may also be an equity investor) takes on the highest level of risk both in terms of their own capital as well as using their balance sheet to provide guarantees for the lender. Both lenders and equity partners will require developers to contribute equity up front so that they have quantifiable “Skin in the Game.”

All three players contribute something essential to a real estate development project, and as such, they typically struggle for the most advantageous position when it comes to sharing profit. A traditional profit split structure will use an inverse hierarchy of front-end risk and payment priority in determining profit splits.

The allocation of risk and return is a central component to commercial real estate development. An IRR waterfall arrangement accomplishes this by positively compensating the developer for meeting or exceeding project expectations and also by shielding the equity investor from unfavorable downside risk.

Let’s consider an example. Prior to a development, an equity investor puts up $4.5 million while a developer contributes $500k. After a 4-year hold and stabilization period, the property sells for $22 million, sales costs are $100,000, a $10 million loan is paid off, $5 million of equity is returned to the partnership, and there is $6.9 million in profit to distribute.

In a traditional payout structure, the equity investor receives an 8% preferred return, and the partnership agrees to split the net profits pari-pasu, or 90/10. From this traditional split structure, the equity investor will receive $10,710,000 – a 24.2% IRR, and the developer will receive $1,190,000 – a 24.2% IRR.

In contrast, the IRR waterfall is a progressive split that will yield a higher proportion of the returns at lower overall profit levels to the investor, while the developer will see a higher return at the higher profit levels. When realized profits are higher, the developer benefits disproportionally from the waterfall structure – this is known as the developer’s “promoted interest,” extra profit earned by the developer for exceeding pre-negotiated benchmarks in the return structure agreement.

IRR waterfall image 2

 

Assuming the same scenario as above, the investor would receive $9,076,584 or $4,576,584 in profit and a 19.2% IRR while the developers would receive $1,008,509 or $508,509 in profit and a 19.2% IRR on their contributed capital. The developers will also realize $1,814,906 in profit as their promoted interest.

IRR waterfall image 3

 

Developer’s returns are significantly more volatile as compared to the equity investor given the inherent risks associated with development (i.e. changing market conditions, long lead times, cost overruns, rising construction costs, etc.). Lenders mitigate this risk by securing the first lien position in the collateral and receiving debt service payments before profits are distributed to the partnership. This volatility is a key reason lenders will require developers to have quantifiable “Skin in the Game,” so when profits are lower than expected, developers won’t be tempted to hand over the keys and walk from the project. Conversely, equity partners (and lenders) want to provide assurance and incentive for a developer’s job well done. To mitigate this risk, equity investors can offer the developer a promoted interest.

Negotiating the IRR waterfall structure can be critical to the success of a commercial real estate investment and transaction. Understanding the nuances of the technique will give you a better understanding of how to maximize your returns and limit your exposure to unfavorable downside risk.

The author, Joshua Siegel, is an associate analyst at Metropolitan Capital Advisors. He can be reached at jsiegel@metcapital.com or by calling our Dallas Office at (972) 267-0600.

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How to Turn a Dud into a Stud: Using Legislation to Reduce the Liability and Costs Associated With Groundwater Contamination

By Duke Dennis

What do parties to a real estate transaction think when they hear that the property acquisition they have been working on has groundwater contamination?

Owner:  How do I limit my liability and the future owner’s liability in order to sell the property?

Lender:  How do I protect my liability if I have to foreclose on the property?

Developer: What is the cheapest way to remediate contamination in order to reduce the development budget?

City Official:  How can we support remediation and development of contaminated properties in our city?

Investor:  How can we limit the costs of remediation so as not to eat up all of my profits?

Normally groundwater contamination would be a deal-killer due to the abnormally high risks and potentially exorbitant costs associated with such properties; however, this does not have to always be the case, especially in Texas where two pieces of legislation were put in place to incentivize remediation and development of properties with this very problem.  The Texas Voluntary Cleanup Program along with the Municipal Setting Designation have changed the way owners, lenders, developers, city officials, and investors look at the prospect of remediating a property with groundwater contamination by reducing the costs and liability of doing so.

Created in 1995 the Texas Voluntary Cleanup Program (“VCP”) offers protection to future lenders, landowners, and all non-responsible parties from liability to the State of Texas only after you have gone through the following steps: the current owner of the property must submit an application for the property to the VCP along with an Affected Property Assessment Report describing the contaminated area of concern and a $1,000 application fee. In the application there must be a signed agreement describing a schedule of events to achieve cleanup and an agreement confirming that the applicant agrees to pay all VCP oversight costs. Post-cleanup applicants will receive a Certificate of Completion (“COC”) from the Texas Commission on Environmental Quality (“TCEQ”), releasing all non-responsible parties from further liability to the state for cleanup of areas covered by the certificate.

The VCP process sounds simple enough, but limiting liability is only half the battle.  The other half is reducing the costs of remediation, so that begs the question, “Exactly what does “cleanup” for groundwater contamination entail under VCP guidelines?”  This is where the second piece of legislation, Municipal Setting Designation (“MSD”), comes in.

Under the VCP an acceptable form of groundwater remediation is obtaining a Municipal Setting Designation.  An MSD is a legally binding ordinance that prevents the use of groundwater at the site for drinking water now or in the future, thereby protecting public health.  Once the MSD has been obtained the subject property is considered to have been remediated, thus reducing the costs typically associated with remediation.  As the steps to entering the VCP were simple and straight forward, so are the steps to gaining an MSD.

To gain an MSD the property owner must do three things:

  • File for a resolution of support within the city that houses the property.
  • Notify landowners with water wells within a 5-mile radius of the subject property receiving the MSD of the following: purpose, eligibility criteria, location and description, type of contamination, and identification of the parties responsible (if known).
  • File an MSD application with the TCEQ along with a $1,000 fee and proof of meeting the first two conditions.

Once the application has been received by the TCEQ, there is a state-mandated 60-day period for the TCEQ to review and render a decision.  At this point if you followed all of the preceding steps to the letter, then it is a mere formality that you will get your MSD. For the cost of a $1,000 application fee and the cost to mail some letters to adjacent land owners you have now successfully remediated your property for a fraction of what it potentially might have cost.  Also, now that you have remediated the contamination you will receive a Certificate of Completion from the TCEQ eliminating any future liability to the State of Texas for cleanup of the property.

Using the Voluntary Cleanup Program and Municipal Setting Designation, you can reduce liability and costs of remediating properties with groundwater contamination.  If you are looking to buy, finance or redevelop a property with groundwater contamination you should be aware of these two pieces of legislation as they can protect your liability and your financial ability to do so.

The Author, Duke Dennis, is a Senior Analyst at Metropolitan Capital Advisors.  Duke may be contacted at ddennis@metcapital.com or (972) 267-0600.

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