Partner Content: NetLeaseX Capital offers family offices direct access to rescue financing investments in real estate

A growing trend for family office investors is to make direct investments in real estate rather than investing passively with fund managers.  Family offices struggle, however, to source a sufficient volume of professionally structured and vetted investment opportunities to enable them to pick and choose the ones that will provide them with superior risk-adjusted returns.  NetLeaseX Capital solves this problem with its curated online investment platform.  Our robust platform enables family offices to source direct investments in real estate, including rescue financing, preferred equity and co-GP investment opportunities.

Family offices and other sophisticated real estate investors can access NetLeaseX’s platform to freely review NetLeaseX’s pre-screened transactions. These opportunities are “investment ready”  because real estate investors and developers, often referred to as sponsors,  have committed in writing to NetLeaseX’s funding proposals and have agreed to pay NetLeaseX a fee related to financing.

Based on the structure of the rescue financing and where it fits in the capital stack, family office investors can expect to earn 14-18% or higher fixed-income returns in a very familiar asset class on a risk-mitigated basis.

As described in our white paper, family office investors can fund direct investments by stepping in and funding the investment as successor in interest to NetLeaseX.  Alternatively, the family office investor can suggest modifications to the investment terms that NetLeaseX initially negotiated with the sponsor in order to:

• Increase the family office investor’s preferred return and/or percentage of project ownership,
• Require the sponsor to increase its investment,
• Obtain downside protection by providing for a “Minimum Target Price”, “Look-Back” IRR, fixed redemption fee, or fixed return multiple upon a sale (see page 17 of NetLeaseX’s white paper),
• Restructure NetLeaseX’s proposed investment as directed by the family office investor, and/or
• Assume the role of the sponsor and have the original sponsor act as a co-sponsor, effectively enabling the family office to “take over” the project (see page 20 of NetLeaseX’s white paper).

Rescue Financing Offers Compelling Returns on a Risk-Adjusted Basis.

In the past, sponsors have sought to raise preferred equity for ground-up development projects.  While there are still opportunities to fund ground-up developments, in today’s market, we believe that a better way to invest in commercial real estate is to provide rescue financing to sponsors, particularly in multifamily.

These types of transactions are opportunistic, highly structured, and are negotiated between multiple stakeholders – a senior lender (and its special servicer if a CMBS loan), the project sponsor and its limited partner investors, and sometimes a mezzanine lender or a third-party preferred equity investor.

Based on the structure of the rescue financing and where it fits in the capital stack, family office investors can expect to earn 14-18% or higher fixed-income returns in a very familiar asset class on a risk-mitigated basis.

Unlike investing in a fund, family office investors providing rescue financing via a direct investment have a much higher level of control and “a seat at the table.”  They may either take the lead in negotiations with the various stakeholders or have NetLeaseX take the lead without incurring advisory fees, and, in either case, confer with and receive support from NetLeaseX as an experienced advisor.

Focusing on Rescue Financing Investment Opportunities.

Rescue financing provides both high returns and control to family office investors and an affordable solution for sponsors.  Investors receive a high rate of return on the rescue financing.  But, since the amount of such investment is typically less than 15% of the balance due on the senior loan involved in the financing, on a relative basis, the investment amount is not excessive.  In addition, since at least a portion of rescue financing proceeds are expended on property improvements, the property’s fair market value typically increases more than the cost of the rescue financing.

Beyond the “affordability” of rescue financing, the sponsor and its limited partners effectively retain a “hope certificate” as a result of their retention of a subordinated interest in the capital stack pursuant to which the sponsor and its limited partners receive all or a portion of their original investment and, in a best-case scenario, some return on their respective investments.

Finally, rescue financing benefits senior lenders who are more likely to agree to reduce the interest rate and/or extend the maturity on the senior loan if such concessions were a precondition for financing from a third-party investor like a family office.  If the senior lender agrees to reduce the interest, this will help reduce the increase in the cost of capital of the rescue financing.

Rescue Financing Example

A sponsor purchased a multifamily property for $50 million and borrowed $35 million from a senior lender.  Due to the increase in interest rates, a poorly performing property manager, increased vacancy, deferred capital expenditures and/or a shortfall of funds needed for unit turns, the property’s current net operating income is less than the amount needed to cover debt service.  In this example, $4 million in rescue financing would enable the sponsor to do one or more of the following:

• Cover additional interest expense to the senior lender due to increase in market interest rates,
• Cover any operating deficits, 
• Pay down a portion of the senior loan,
• Gain the leverage needed to facilitate favorable loan workouts with CMBS and other types of lenders to reduce interest rates, extend maturity dates, and/or release or otherwise reduce personal loan guarantees,
• Fund an interest reserve for the senior loan,
• Fund capital expenditures, unit turnover costs and/or renovations, and/or
• Fund tenant buildouts, and/or pay leasing commissions if the property type is other than multifamily.

Although NetLeaseX focuses on multifamily properties, there are opportunities in other property types as well.  We will pursue such opportunities on a case-by-case basis.

Takeaways and Key Points in Structuring Rescue Financing.

• Lenders who hold impaired loans generally require their borrowers to invest new funds into their property as a condition of their participation in loan workouts.  The borrower’s new investment can be funded by arranging rescue financing from NetLeaseX and its family office investors.
• Following the maxim, “last money in, first money out,” rescue finance investors are typically paid back first with an agreed “profit” before the sponsors’ and limited partner investors’ investments are returned. In more dire situations, the “last money in, first money out” maxim can also extend to the senior lender as well, where the senior lender may agree to bifurcate a portion of the senior loan into a B note and subordinate such amount to the rescue financing investor first receiving its investment and agreed “profit” (see page 31 of NetLeaseX’s white paper).
• Often, a third party like NetLeaseX and its family office investor can negotiate more favorable concessions from a lender holding an impaired loan than the lender’s borrower.
• NetLeaseX has the expertise and skills needed to convince senior lenders to relieve the sponsors from some or all recourse related to their loans, recourse on certain loan carve-outs and/or push back or remove a rebalancing test for the sponsor.
• Rescue financing can be structured in a myriad of different ways with varying levels of risks and rewards.
• The senior lender receives the benefit of the rescue financing being invested in the senior lender’s collateral without the senior lender having to advance the funds itself.
• A senior lender may agree to bifurcate a portion of the senior loan amount and/or future interest due on the senior loan into a B note and/or reduce the interest rate on the senior loan if the proceeds from the rescue financing are used to increase the value of the lender’s collateral.
• Since the original loan guarantors stay in place, family office investors can make leveraged investments in properties subject to senior loans on the properties without providing financial disclosures and without assuming any obligations or recourse on the senior loans.
• If a senior lender agrees to reduce the pay rate to 5% per annum, for example, on the senior loan, then, since payment of interest on the senior loan in excess of the pay rate is subordinated to payment of the family office investor’s investment, its effective cost of capital is equal to the 5% pay rate.

More Opportunities to Make Rescue Financing Investments.

In today’s market, there are substantial opportunities for family office investors to provide rescue financing because senior lenders prefer to work with their borrowers rather than foreclose on collateral, sell their loan at a discount, accept a short sale or accept a deed in lieu of foreclosure. 

Family office investors may review the transactions that are currently available in NetLeaseX’s pipeline here.  And they can review an article Ron Zimmerman wrote on preferred equity and a two-part article on rescue financing here.

In providing rescue financing, family office investors with real estate experience and expertise can generate out-sized returns with mitigated risks by “carving out” a fixed-income investment in practically any distressed property with motivated stakeholders.  To discuss NetLeaseX’s white paper, this article and/or make direct investments, family office investors can reach Ron Zimmerman at (513) 621-1031 or via email at ronz@NetLeaseX.com. 

Ron Zimmerman is president of NetLeaseX Capital LLC, an investment banking and capital markets advisory company in Cincinnati, Ohio.  Mr. Zimmerman has significant experience in raising investment capital for real estate investors and developers, structuring real estate financial transactions and tiered financings of acquisitions, leveraged recapitalizations, financial restructurings and workout of commercial and consumer loans.  Mr. Zimmerman has more than 38 years of experience in the commercial and residential real estate markets and is a licensed real estate broker.  You can reach Mr. Zimmerman at (513) 621-1031 or ronz@NetLeaseX.com.