District Capital Stack

CRE Debt Capital Stack

5/6/2019 by Kevin Henderson

A capital stack is a visual representation illustrating the position of cash within a property’s capitalization, i.e., how the debt or equity – or a combination thereof is broken out. As a rule, debt in a transaction is senior in priority to equity, whereby its position is first to be repaid and the most protected should property values fall. All the equity in a transaction would have to be eliminated before a debt’s position would be adversely affected. This is referred to as an equity cushion. Due to the inherent safety of this position within the capital stack, yields for debt are generally lower than that of equity with a stated return and excess cash flowing to equity partners.

Within the world of commercial real estate (“CRE”) debt, there lies a variety of different products – all able to be tailored to a lender’s discretion, borrower’s needs and business plan. Below is a summary of the primary forms of debt that currently exist in the CRE marketplace.

  • Senior Secured Debt
    • Senior Secured Debt is the most traditional form of debt in real estate whereby the loan dollars are “secured” by the real estate. Senior debt is in the “first” position, meaning that all cashflows generated by the property (after paying operating costs) first will go towards paying the senior lender’s interest payment. Excess cashflow will then be disseminated according to how the transaction is capitalized. Due to the fact that senior debt is secured by the property, the Lender in the transaction has the ability to foreclose upon the collateral and effectively assume ownership should the Borrower default upon his obligation as outlined by the Loan Agreement that was signed by both parties upon the loan’s funding.
    • Senior Secured Debt has no specific loan term, however the notes are typically longer in duration (5-30 years depending on the lender, property type, market, etc.)
  • Bridge Debt
    • Bridge Debt is typically similar in seniority as senior secured debt but typically short term in order to “bridge” a property from a non-stabilized standpoint to a stabilized state. Conditions surrounding a property that would make bridge debt appropriate for a transaction are low occupancy, leverage requests (bridge loans often will be originated with a higher Loan-to-Value (LTV) than typical bank senior loans), capex/repositioning plan, non-traditional transaction structure, short-term ownership and other factors. Bridge Debt is typically more expensive than traditional senior secured debt, often 200-500 bps higher, to account for the increased risk. Additional loan structure is typically put in place as well in order to ensure timely debt service payments, budget for project completion and to minimize default risk. Interest and/or construction reserve accounts are typical features found in a bridge loan.
  • 2nd TD Debt
    • 2nd TD Debt is capital that is placed “junior” or 2nd in seniority to senior debt, however, but it still has a secured interest in the underling property. 2nd TD debt is often used in cases when a real estate transaction requires additional leverage; but the Borrower does not want to relinquish additional equity or cashflow disbursements (via convertible Mezzanine Debt or Preferred Equity Positions). Due to the increased risk profile of the debt on the capital stack, 2nd TD debt is often originated at rates 400-600 bps higher than the senior note (dependent upon the leverage point). Additionally, the 2nd TD position is junior in the foreclosure to a senior loan and has less likelihood of being made whole upon an adverse event.
  • Mezzanine/Subordinated Debt
    • Mezzanine/Subordinate Debt is different from Senior Secured, Bridge Debt and 2nd TD Debt in that the loans dollars are not secured by the physical real estate, but rather secured by the Borrower/interest in the equity. Due to the increased risk (due to both leverage and lack of security in the underlying property) interest rates charged for Mezzanine/Subordinate debt are often between 10-20%. Additionally, covenants are placed upon the Borrower restricting additional debt and taking cash “out” of the property through other means (i.e. selling an equity interest, recapitalizing other debt positions, etc).

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