Real Estate Private Equity Markets

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Real Estate Private Equity Markets

  1. 1. Real Estate Private Equity Markets
  2. 2. Structural Effects on NOI and Cash Flow     NOI (or Cash Flow) Land owner (unsubordinated) First mortgage Second mortgage or Mezzanine financing Equity (priority) Equity (subordinated) Land owner (subordinated)         Tranches--Slicing a Transaction into Components
  3. 3. Sources of Equity Financing <ul><li>Owner/developer personal resources </li></ul><ul><li>Friends, family, and business associates </li></ul><ul><li>Third-party equity sources </li></ul><ul><ul><li>High net worth individual investors </li></ul></ul><ul><ul><li>pension funds </li></ul></ul><ul><ul><li>Opportunity funds, mezzanine investors, hedge funds </li></ul></ul><ul><ul><li>Life insurance companies </li></ul></ul><ul><li>Creative Sources </li></ul><ul><ul><li>Land Owners. Contribute land in exchange for an interest in the completed property </li></ul></ul><ul><ul><li>Land lease </li></ul></ul><ul><ul><li>Seller financing </li></ul></ul><ul><ul><li>Any other source with potential to gain from the transaction </li></ul></ul>
  4. 4. Financial Structures Utilized to Own or Invest in Real Estate <ul><li>“ Free & Clear” or unlevered100% equity, without use of borrowed funds </li></ul><ul><li>Leveraged </li></ul><ul><ul><li>Equity combined with borrowed funds </li></ul></ul><ul><li>Hybrid </li></ul><ul><ul><li>Combines equity, borrowed funds, and mezzanine financing </li></ul></ul><ul><ul><ul><li>Mezzanine financing may be structured as equity and/or debt </li></ul></ul></ul>
  5. 5. Unlevered Required Rates of Return for Various Real Estate Investment Strategies Risk Free Rate Investment Rate U.S. 10-Year Treasury Bonds (6/09) 3.75% Income Strategy Triple Net Leased Property *Investment Grade Credit 7.00% - 8.50% (+3.25% - 4.75%) Core Strategy Fully leased, multi-tenant property 8.00% - 10.00% (+4.25% - 6.25%) Value-Added Strategy Partially leased, below market rents, renovation 10.00% - 15.00% (+6.25% - 11.25%) High-Yield Strategy Non-investment grade CMBS, Mezzanine Debt (up to 75% LTV) 13.00% - 18.00% (+9.25% - 14.25%) Opportunistic Strategy Development, lease-up, non-performing loans 20.00% + (+16.25% - ???)
  6. 6. Joint Ventures (aka Partnership) <ul><li>Sale and financing transactions are more “commodity-like” whereas joint ventures are individually negotiated and tailored transactions </li></ul><ul><li>A joint venture may be formed to: </li></ul><ul><ul><li>Acquire a specific property, a portfolio of properties, or an operating company </li></ul></ul><ul><ul><li>Recapitalize an existing partnership </li></ul></ul><ul><ul><li>Develop a property </li></ul></ul>
  7. 7. <ul><li>Direct equity investments and/or equity joint ventures are available for </li></ul><ul><ul><ul><li>All product types </li></ul></ul></ul><ul><ul><ul><li>All acquisition models-opportunistic, value creation, rehabilitation, yield, etc. </li></ul></ul></ul><ul><ul><ul><li>Utilize third-party financing (70% to 80%) </li></ul></ul></ul><ul><ul><ul><li>Term- 1 to 7 years </li></ul></ul></ul><ul><ul><ul><ul><li>Pre-defined exit strategy </li></ul></ul></ul></ul>Sources of Equity Financing
  8. 8. Structuring Joint Ventures <ul><li>Each joint venture is idiosyncratic; there are no pre-set terms and conditions </li></ul><ul><li>Terms to be negotiated include: </li></ul><ul><ul><li>Contributions </li></ul></ul><ul><ul><li>Preferred returns and “Claw-backs” </li></ul></ul><ul><ul><li>“ Promotes” </li></ul></ul><ul><ul><li>Governance, guarantees (if any), fees and transaction costs and expenses </li></ul></ul><ul><ul><li>Winding-up, Buy/Sell </li></ul></ul>
  9. 9. Joint Venture Financing <ul><li>One method public and private real estate operating companies (REOC) are increasingly using to access capital is joint ventures with institutional investors such as pension funds. </li></ul><ul><li>Involve formation of new, special-purpose entity which is utilized to own the properties of the joint venture. </li></ul><ul><li>Involve the contribution of existing properties owned by the REOC, acquisition of properties from a third-party, to-be-developed properties, or a combination of all three. </li></ul>
  10. 10. Joint Venture Financing <ul><li>If the joint venture involves existing properties owned by the REOC, the REOC contributes the properties at an agreed upon acquisition value while the institutional investor contributes cash. </li></ul><ul><li>Profit sharing is based on the value of the equity contributed by the parties to the joint venture. </li></ul>
  11. 11. Joint Venture Financing <ul><li>Under normal circumstances, the REOC receives an asset management for managing the joint venture as well as fees for property management and leasing the joint venture’s property. </li></ul><ul><li>Joint ventures have a specified life or term, negotiated among the parties at the inception of the joint venture. </li></ul><ul><li>Upon expiration, the properties are liquidated either through the sale of the properties to a third party, or acquired by one of the joint venture participants based upon a pre-negotiated formula or right of first refusal. The REOC may receive a disposition fee for selling the properties to a third party. </li></ul>
  12. 12. Private Real Estate Equity Capital Markets -Range of Required Rates of Return <ul><li>Equity investor contributes up to 90% of capital required; real estate partner contributes balance </li></ul><ul><li>Real estate partner’s returns subordinated to equity investor receipt of: </li></ul><ul><ul><li>Current return of 4% to 8%, cash-on-cash </li></ul></ul><ul><ul><li>Cumulative return (look-back IRR) of 12% to 16% </li></ul></ul><ul><li>Real estate partner handles day-today operations; paid market rate fees (which increase return on investment) </li></ul>
  13. 13. Case Study Terms of Acquisition JV <ul><li>Structure: Limited Liability Company comprised of a subsidiary of the REOC (as managing member) and an affiliate of the institutional investor </li></ul><ul><li>Purpose: To acquire $250 million of industrial property </li></ul><ul><li>Invested Capital: Equity of $125 million, with 50% leverage; the institutional investor contributed 50% ($62.5 million); the REOC contributed 50% ($62.5 million) </li></ul>
  14. 14. Case Study Terms of Acquisition JV <ul><li>Leverage: 50% of the total acquisition price of the properties </li></ul><ul><li>Term: Minimum 6 years; maximum 8 years </li></ul><ul><li>Value-add Component: Improve property, create the value, and sell once stabilized to create Net Investment Income </li></ul><ul><li>Management: Major decisions (Sale, Finance, Liquidation, Management Change) require both partners concurrence. Day to day operations and management handled by REOC. </li></ul>
  15. 15. Case Study Terms of Acquisition JV <ul><li>Fees: The REOC will receive an disposition fee equal to 1% of the sales price, management fees and leasing commissions at market rates, and an asset management fee equal to 0.5% of the value of the joint venture properties. </li></ul>
  16. 16. Case Study Acquisition JV Waterfall Distribution <ul><li>First, to repay capital contributions made by each partner (typically 50%/50%) </li></ul><ul><li>Second, to pay each partner a 10% cumulative annual return on capital </li></ul><ul><li>Third, 35% to Institution and 65% to REOC </li></ul><ul><li>Projected Leveraged return was 11% for Institution and approximately 13% for REOC. </li></ul>
  17. 17. Case Study Terms of Development JV <ul><li>Structure: Individual Limited Liability Company comprised of a subsidiary of the REOC and an affiliate of the institutional investor </li></ul><ul><li>Purpose: To develop $300+ million of multi-family property </li></ul><ul><li>Invested Capital: Equity of $100 million, with 70% leverage; the Institutional Investor contributes 85% ($85 million); the Developer contributes 15% ($15 million) </li></ul>
  18. 18. Case Study Terms of Development JV <ul><li>Leverage: 70% of the development cost </li></ul><ul><li>Term: Develop, Stabilize, Sell (typically 3 yrs) </li></ul><ul><li>Management: Major decisions (Sale, Finance, Liquidation, Management Change) require both partners concurrence. Day to day development operations and management handled by REOC. </li></ul>
  19. 19. Case Study Terms of Development JV <ul><li>Fees: Developer receives a GC fee of 5% of hard costs, development fee of 3% of total costs, and a management fee of 3% of gross revenues </li></ul><ul><li>Cost Overruns: Cost overruns offset by Developer’s fees, then 85% Institutional Investor and 15% Developer </li></ul>
  20. 20. Case Study Development JV Waterfall Distribution <ul><li>First, to repay capital contributions made by each partner (typically 85%/15%) </li></ul><ul><li>Second, to pay each partner a 10% cumulative annual return on capital </li></ul><ul><li>Remaining proceeds split 60% to Institutional Investor and 40% to Developer </li></ul><ul><li>Target IRR 18% to Institutional Investor </li></ul>
  21. 21. Typical Waterfall Distribution <ul><li>Current Environment: The capital partner has more leverage. This means that the hurdle rates may be higher, the promotes for the LP may be lower and/or fees may be reduced to the operating partner. In certain cases all 3 of these things have occurred. </li></ul>
  22. 22. Cash Flow Distributions Current Yield Achieved Investor REOC Up to a 15% cumulative annual yield 80% 20% Up to a 20% cumulative annual yield 65% 35% Thereafter 50% 50%
  23. 23. Proceeds of Sale IRR Achieved Investor REOC Up to a 15% IRR 80% 20% Up to a 20% IRR 65% 35% Above 20% IRR 50% 50%

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