Equity Loans for commercial real estate are a combination of second position loans or loans on partnership interests, providing an alternative to raising equity capital.
For many established real estate entrepreneurs, raising equity is expensive, dilutive, and a tedious process. Obtaining an Equity Loan is a viable alternative that allows them to capitalize their projects without giving away ownership or control rights. Moreover, it also minimizes having to manage multiple equity partners.
How are Equity Loans Used?
Equity Loans offer a combination of two different loan structures to achieve maximum leverage and minimize or eliminate the need to raise equity.
First, for new projects:
Second-position loans combine with first mortgage loans to maximize leverage up to 75% or 90% LTC. This reduces the required equity contribution at the deal-level to as little as 10% or 25% of the deal’s cost.
Second, to cover the required equity:
For real estate entrepreneurs with a real estate net worth of $5 million, or greater, Equity Loans may be structured to unlock trapped liquidity in their net worth. Equity Loans use the real estate entrepreneur’s net worth as collateral for second position loans and loans on partnership interests. This newfound liquidity may then be used to fund the required equity on new projects.
These two structures when combined can allow the entrepreneur to borrow up to 100% of the project cost. This means that they keep more ownership and have a cheaper alternative to raising equity.
Why Is it Beneficial?
Real estate entrepreneurs love the idea of growing the number of properties in their portfolio. What they don’t love is growing the number of partnerships that often coincide with this net worth growth.
Equity Loans help you obtain higher leverage than first mortgage lenders alone are unable to provide. Better yet, they’re more cost-efficient than raising common equity.
Common equity is typically comprised of capital invested from general partners, limited partners, or simply the borrower’s own capital. The problem using this type of capital in excess is that it’s the most expensive type of money to raise.
These common equity investors typically look for returns anywhere from 12% to 25% IRR, or more. This compares to the cost of Equity Loans which range from 8% to around 16% IRR – which may be a substantially more cost-efficient alternative.
The basic rule to keep in mind is that Equity Loans provide an opportunity for established real estate borrowers to find cheaper sources of capital and retain control on their deals.
Read Next: “5 Methods of Collateralizing Equity Loans”
Disclaimer: If you are structuring or negotiating an Equity Loan with a capital source or looking to invest in one, it is important to always seek appropriate legal and financial counsel. Valencia Realty Capital, LLC does not provide any legal or financial advice. This information is for educational purposes only.