Creating an Optimal Multi-Family Capital Stack

Creating Optimal Multi-Family Capital Stacks

Pros & Cons of Creating Optimal Capital Stacks with the Right Balance of Financing & Equity.

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As a multi-family developer, you know that creating optimal capital stacks is critical to the success of each project you undertake. By leveraging the right combination of all available equity and financing options, you seek to secure the correct blend of funding needed to complete your project while minimizing the cost of capital and maintaining the desired level of ownership.

How do you, as the developer, get the best of all worlds?

When evaluating equity options, you understand it is important to consider the trade-offs between ownership, control and the gap that needs to be filled between the developer’s own equity component and what a senior lender is requiring as equity in the project. While outside equity investors can provide valuable expertise and industry connections, they will also require a share of the profits and likely a say in project decisions. However, by selecting the right equity partner, you may be able to leverage their resources and expertise to maximize the potential of your project however you do not remove the high return on investment they would be seeking as well as the “seat at the table” they may demand. How then do you, as the developer, get the best of all worlds?

Traditional Senior Loans for multi-family projects are, as you are acutely aware, somewhat of a speciality with a number of well known banks who take the lead in this market. The selection of a suitable senior lender is becoming more important than ever. Here are the Top 5 Commercial Construction Lenders of 2022.

Mezzanine debt financing can provide valuable sources of funding beyond traditional bank financing. Mezzanine financing can be particularly useful when bank financing falls short however most mezzanine lenders understand the value of their money so this capital tends to come at a very steep price. Traditional mezzanine financing typically involves much higher interest rates and many times requires guarantees or other forms of collateral beyond what a senior lender will be seeking as the mezzanine investment is subordinate to the senior loan.

Government incentives including – TIF. In many cases, government incentives are structured as reimbursable sources of capital. This means that when new revenues are generated, the government body directs either all or a portion of these funds back to the developer. While this may seem beneficial at first glance, there are alternative solutions that may be more advantageous.

C-PACE. Similar to other financing methods, C-PACE offers a way to cover the initial expenses linked to energy efficiency or renewable energy upgrades. However, what sets it apart is the repayment method, which involves a voluntary tax assessment. This program offers advantages like extended financing periods and the ability to transfer repayment responsibilities to future property owners. As a result, C-PACE makes it more appealing for businesses to invest in long-term, extensive building projects that might not be feasible through conventional financing options.

EB-5 Capital. As you evaluate your financing options, it is worth considering the potential benefits of utilizing EB-5 capital as a replacement for some of the more expensive capital sources under consideration. By doing so, you might find that you can achieve more favorable financial terms for your project.

Maximize the potential of your multi-family projects

As an experienced developer you understand the importance of evaluating each options pros and cons and determine which combination of equity and financing will provide the necessary funding while minimizing the amount of equity given up and the project’s overall cost. By taking the time to structure the optimal capital stack, you can maximize the potential of your multi-family projects and create successful investments that generate significant returns.

More than just securing funding

In addition, it’s essential to keep in mind that successful multi-family development requires more than just securing funding. Effective project management, market research, and strategic decision-making are also critical components of success. As an expert in the field, you likely already understand the importance of these factors and are well-equipped to navigate the complexities of the multi-family development process.

Creating Optimal Multi-Family Capital Stacks will explore the pros and cons of each financing and equity option available to experienced developers.

Pros and cons: Equity and Debt. 

Equity

The following equity options are traditionally considered by experienced developers.

Private Equity

Pros:

  • Private equity investors can provide substantial capital for multi-family projects, which can help developers complete projects on a larger scale or more quickly.
  • Private equity investors can provide a measure of financial stability to a project, which can be beneficial during periods of economic uncertainty.
  • Private equity firms typically have extensive industry knowledge and expertise, which can be valuable resources for developers.

Cons:

  • Private equity investors may demand a significant ownership stake in the project, which can dilute the developer’s control over the project.
  • Private equity investors may impose restrictions on the developer’s ability to make decisions about the project, which can limit the developer’s flexibility.
  • Private equity firms may require a high rate of return on their investment, which can lead to higher project costs.
Joint Venture

Pros:

  • Joint venture partners can provide capital, expertise, and resources, which can help the developer complete the project successfully.
  • Joint venture partners can bring industry contacts, which can be valuable resources for the developer.
  • Joint venture partners can help reduce the developer’s financial risk by sharing the financial burden of the project. 

Cons:

  • Joint venture partners may have different opinions or ideas about the project, which can lead to conflicts.
  • Joint venture partners may have differing timelines for the project, which can cause delays or disruptions.
  • Joint venture partners may require a significant ownership stake in the project, which can dilute the developer’s control over the project.
Real Estate Investment Trusts (REITs)

Pros:

  • REITs can provide a significant amount of capital for multi-family projects, which can help developers complete projects on a larger scale and/or more quickly.
  • REITs are often experienced operators of multi-family properties, which can provide valuable resources and expertise to the developer.
  • REITs can offer a level of financial stability to the project, which can be beneficial during periods of economic uncertainty.

Cons:

  • REITs may require a significant ownership stake in the project, which can dilute the developer’s control over the project.
  • REITs may have different ideas or opinions about the project, which can lead to conflicts.
  • REITs may require a high rate of return on their investment, which can lead to higher project costs.

“Selecting the right equity partner is crucial to the success of a multi-family project. Not only do they bring capital, but they also offer valuable resources, expertise, and connections,” says Jonathan Gray, President and COO of Blackstone Group1Jonathan Gray, as quoted in “The Long View: Blackstone’s Gray on the Future of Real Estate,” Commercial Property Executive, September 27, 2016. https://www.cpexecutive.com/post/the-long-view-blackstones-gray-on-the-future-of-real-estate/

Debt

Unlike equity, debt financing involves borrowing money from a lender and paying it back with interest over time. The following debt options may be considered by experienced developers.

Traditional Bank Financing

Pros:

  • Traditional bank financing is often a reliable and cost-effective option for developers looking to borrow money for their multi-family projects.
  • Banks typically offer competitive interest rates and flexible repayment terms.
  • Traditional bank financing can be easier to obtain than other forms of debt financing.

Cons:

  • Traditional bank financing may require significant collateral, which can be difficult for some developers to provide.
  • Traditional bank financing may have strict requirements for the developer’s creditworthiness or financial history.
  • Traditional bank financing may not provide enough funding to cover the full cost of the multi-family project.
Mezzanine Financing

Pros:

  • Mezzanine financing can provide the additional funding needed to complete a multi-family project when traditional bank financing falls short.
  • Mezzanine financing typically offers more flexible repayment terms than traditional bank financing.
  • Mezzanine financing can be structured to minimize the amount of equity that must be given up by the developer.

Cons:

  • Mezzanine financing typically involves higher interest rates than traditional bank financing.
  • Mezzanine financing may require the developer to provide personal guarantees or other forms of collateral.
  • Mezzanine financing may require a larger equity stake in the project than traditional bank financing.

“Mezzanine financing can be an attractive option for developers looking to bridge the gap between traditional bank financing and the total project cost, but it’s important to understand the higher interest rates and potential collateral requirements that come with it,” notes Greta Guggenheim, CEO of TPG Real Estate Finance Trust 2Greta Guggenheim, as quoted in “The Current State of Mezzanine Financing,” Commercial Observer, November 6, 2018. https://commercialobserver.com/2018/11/the-current-state-of-mezzanine-financing/

EB-5 Capital

Pros:

  • EB-5 capital is a form of financing that is specifically designed to fund job-creating projects in the United States.
  • EB-5 capital can provide significant funding for multi-family projects.
  • EB-5 capital, as debt*, typically offers lower interest rates than mezzanine financing or other forms of debt financing. *EB-5 capital can take the form of either debt or equity.

Cons:

  • EB-5 capital requires the developer to comply with strict regulations and guidelines, which can be time-consuming.
  • EB-5 capital requires the developer to demonstrate that the project will create the required number of jobs for qualified employees.
  • EB-5 capital may require the developer to provide significant collateral.

“EB-5 capital can provide a significant funding boost for multi-family projects, but developers must be prepared to navigate strict regulations and job creation requirements,” says Clem Turner, an EB-5 attorney at Homeier Law PC3Clem Turner, as quoted in “How EB-5 Financing Works for Real Estate Projects,” The Real Deal, November 7, 2017. https://therealdeal.com/issues_articles/how-eb-5-financing-works-for-real-estate-projects/

PACE loan 

Pros:

  • PACE financing is often easier to qualify for and can provide access to capital that might not otherwise be available.
  • PACE loans allow property owners to make energy efficiency improvements without incurring large upfront costs.
  • Energy efficiency upgrades can increase the value of a property, making it more attractive to potential buyers or tenants.
  • PACE loans offer longer repayment terms than traditional bank loans, typically up to 20-25 years. This can result in lower monthly payments, making it easier to manage cash flow.

Cons:

  • PACE loans typically have higher interest rates than traditional bank loans.
  • PACE loans are repaid through a special assessment on the property tax bill which could make it difficult to sell or refinance the property.
  • Not all properties are eligible for PACE loans, and the energy efficiency upgrades must meet certain criteria.
  • PACE programs are not available in all areas, which can limit access to PACE financing.
  • Because the loan is tied to the property, not the property owner, the new owner of the property assumes responsibility for the remaining balance of the loan. This can make it more difficult to sell the property, particularly if the loan balance is high. 
TIF

Pros:

  • Provide developers with access to funding that they may not otherwise be able to obtain through traditional financing options.
  • Help spur economic development in blighted areas or areas that are in need of redevelopment. This can lead to increased property values, job creation, and increased tax revenue for the local government.
  • Often involves a sharing of risk between the developer and the local government. This can help to mitigate some of the risks associated with large-scale development projects.
  • Can be structured with customizable terms to meet the specific needs of the project.

Cons:

  • Shifting tax revenue: One of the main criticisms of TIF is that TIF can shift tax revenue away from other local government services, such as education or public safety.
  • TIF often depends on the accuracy of the initial projections for the increase in property tax revenue, which can be difficult to predict. If the projections are inaccurate, the value of the TIF may never come to fruition.
  • TIF can be controversial, and there may be public perception issues associated with the use of public funds to finance private development projects.
  • TIF typically involves a long repayment period, often over several years. This can be a disadvantage for developers who are looking for shorter-term financing options.

Conclusion

Creating optimal multi-family capital stacks for a multi-family project requires careful consideration of the available equity and financing options. Experienced developers should evaluate each option’s pros and cons to determine which combination of financing and equity will provide the necessary funding while minimizing the amount of equity given up and the project’s overall cost. By taking the time to structure the perfect capital stack, experienced developers can maximize the potential of their multi-family projects and create successful investments that generate significant returns.

  • 1
    Jonathan Gray, as quoted in “The Long View: Blackstone’s Gray on the Future of Real Estate,” Commercial Property Executive, September 27, 2016. https://www.cpexecutive.com/post/the-long-view-blackstones-gray-on-the-future-of-real-estate/
  • 2
    Greta Guggenheim, as quoted in “The Current State of Mezzanine Financing,” Commercial Observer, November 6, 2018. https://commercialobserver.com/2018/11/the-current-state-of-mezzanine-financing/
  • 3
    Clem Turner, as quoted in “How EB-5 Financing Works for Real Estate Projects,” The Real Deal, November 7, 2017. https://therealdeal.com/issues_articles/how-eb-5-financing-works-for-real-estate-projects/
Author Profile

Steve Parnell

Managing Member at American Investment Migration LLC

Steve is a highly experienced property finance professional with over 40 years of experience in the industry. As the founder of two successful real estate finance companies—one in the UK and another in the USA—Steve has been involved in property finance since 1983.

In 2008, Steve became involved in the world of EB-5, and has since worked with clients from over 34 different countries. His extensive knowledge and expertise in the field make him well-equipped to offer valuable guidance and advice.

This website is owned and operated by American Investment Migration LLC. (AIM) - American Investment Migration LLC provides consulting services to developers seeking investment capital by way of the EB-5 program. American Investment Migration LLC is not a registered broker dealer. It is anticipated that any Securities that may be offered associated to a project in which AIM has consulted to a developer will be offered directly by the issuer or through a Broker/Dealer Member FINRA / SIPC.

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