The ABCs of financing a condo tower

Prior to the financial-crisis of 2008, financing a condominium building was relatively simple. Since then, however, U.S. banks are less willing to lend the large sums required and, as such, the tiers of equity and debt needed to get the job done have become all the more complicated.

Developers are facing a serious crunch in the condo financing market banks are weary of backing new luxury projects and investment funds that are willing to do so are charging a pretty penny for their money so if you want to build a condo tower you’re going to have to get really creative here’s how it breaks down a developer looking to build a condo will typically

Start with a chunk of senior debt this is usually a loan from a major bank or their recently other non traditional lenders jumped into the space this is the least risky kind of debt and is backed by the firm’s assets senior debt boasts the highest priority among the different types of debts which means it must be paid back first the senior lender can also place

Restrictions on the other debt and equity that the developer takes on for example it can limit the loan to cost ratio on the project the firm also needs the approval of the senior lender before it receives any other kind of debt or equity the senior lender will go through processes like know your customer which is designed to make sure mezzanine loans and preferred

Equity aren’t coming from questionable sources one level up will get to the mezzanine debt the capital is treated like equity on the company’s balance sheet and is usually acquired via a holding company the mezzanine lenders eaves a pledge of equity as collateral this means if things go wrong the mezzanine lender can become the owner of the real estate mezzanine debt

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Usually comes from debt funds private equity funds or foreign sources increasingly developers are stepping into the space since it’s a way for them to make money without taking on the risk of being the equity stake holder and it puts them in pole position to take control of the property then we get to preferred equity this is a hybrid of equity and debt in that it

Looks like equity but has debt like features preferred equity can be structured more flexibly than a mezzanine loan when it comes to collateral and rates of return this makes it useful when maneuvering or restrictions that come from senior debt this kind of equity is subordinate to mez debt which makes it riskier but the lender of preferred equity gets a preferred

Return over a specified investment term which is at a higher rate than the interest on the senior debt if the developer went bankrupt preferred equity will be repaid for a prearranged operate agreement of some kind this could be the right to take over management of the firm or even force a sale of the property though they are guaranteed a return they usually receive

A lower level of profits than the true equity investors preferred equity can come from foreign investors or family individuals at the top of the deck is true equity which refers to all other equity involved like the capital bar by the firm or other owns so back to financing a building here’s how it used to work back in 2006 banks would often lend sixty to seventy

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Percent of the cost of a condo project in some cases more than seventy five percent on average mezzanine loans would make up roughly another fifteen percent and the final 10 percent would be true equity these days banks aren’t willing to go that far so while some developers can afford to fill the gap with their own funds others have to find alternatives that are

Often more expensive and less secure this is where it becomes a more complicated stack post 2008 fundraising often looks more like this forty five to sixty percent senior debt up to 30 percent mezzanine desam preferred equity and the rest true equity in the most complex scenarios the financing for a condo project can include upward of four layers of mezzanine debt

And preferred equity from various sources the larger the deal the more layers you need and the more specialized the asset type the more complicated the capital step after the crash complicated financial structures were considered to be over but until banks become more willing to lend the large sums required developers who want to build big will have no choice but to embrace complexity

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The ABCs of financing a condo tower By The Real Deal