A company named JCR Capital sent me an email flyer several months ago advertising their equity capital for value-add real estate investments.<\/p>\n
Value-add commercial real estate investments<\/strong><\/em> typically target properties that have in-place cash flow, but they seek to increase that cash flow over time by making improvements to, or repositioning, the property. \u00a0In other words, the property has tenants, but they are paying substantially below the potential rent that the property could be getting.<\/p>\n In a value-add investment deal,\u00a0the transaction\u2019s sponsor makes an active effort to elevate the income stream of the property, typically through a significant capital improvement program, such as a partial or property-wide renovation. \u00a0Examples of such improvements might include new paint, new signage, renovating the lobby, and improving the security of the property and the parking area, etc.<\/p>\n In their marketing flyer, JCR Capital advertised preferred equity, joint venture equity, and programmatic equity. \u00a0Programmatic equity? \u00a0What the heck is programmatic equity?<\/p>\n Before we get into programmatic equity, lets first do a quick review of the term, “equity”. \u00a0Equity is not just the difference between what your house is worth and the balance on your first mortgage.<\/p>\n Equity<\/strong><\/em>\u00a0– in the context of real estate – is the money that the owner stands to lose before “the bank” loses its first penny. \u00a0Obviously, “the bank” could also mean a credit union, a life company, a conduit, or any other type of real estate lender.<\/p>\n Equity is often referred to as the first-loss piece<\/strong><\/em>. \u00a0If anyone is going to lose any money on a real estate deal, the first guy to lose a chunk out of his tush is the equity holder (the owner).<\/p>\n Example:<\/strong><\/p>\n ABC Development Company specializes in turning around big apartment projects that have become run down. \u00a0In downtown Washington, DC, ABC Development learns of a 360-unit apartment project within two miles of Capital Hill. \u00a0The well-located apartment project was once filled with ambitious, young political staffers; but when the old man died, and his wife took over the management, the condition of the property and the rents plummeted.<\/p>\n ABC Development can acquire the property for just $32 million, but the renovation costs are another $9 million. \u00a0With an interest reserve and the other necessary soft costs, the total project cost is $46 million. \u00a0The bank, with whom ABC Development has a relationship, will only loan up to 70% of the total cost because the project has become a big drug house and a gang hang-out.<\/p>\n A huge renovation project like this needs to be structured like a construction loan. \u00a0Who remembers the four elements of\u00a0Total Cost? \u00a0<\/strong><\/em>Of course, there is the land cost (in this case, the cost of the land and<\/em> the building), and then there are the hard costs (bricks and mortar). \u00a0What else? \u00a0Soft Costs – that’s right!<\/em> \u00a0Good job.<\/p>\n But you are still forgetting the fourth element of Total Cost (of a development project). It’s the contingency reserve. \u00a0A good rule of thumb when computing the contingency reserve is to\u00a0use\u00a05% of hard costs and soft costs.<\/strong> \u00a0Why not 5% of the land cost? \u00a0Because by then the developer already knows the cost of the land. \u00a0There is NOT going to be a cost overrun in connection with the land.<\/p>\n Therefore the total cost of a development project is the land cost, plus the hard costs, plus the soft costs<\/strong><\/em> (interest reserve, architectural fees, engineering fees, points, closing costs, etc.), plus the contingency reserve.<\/p>\n Okay, now let’s get back to ABC Development’s big value-add deal. \u00a0We said the total cost was $46 million, and the bank was willing to lend $32.2 million – which is 70% of the total cost. \u00a0Therefore ABC Development will need to contribute $13.8 million. \u00a0The development company has $3.8 million to contribute, so it will need an equity provider willing to put up the remaining $10 million.<\/p>\n This is the type of value-add deal that would be perfect for the nice folks at JCR Capital. \u00a0Their transaction sizes include equity contributions of between $5 million and $50 million nationwide. \u00a0(We are talking large deal sizes here, folks. \u00a0The property should at least be worth $20MM.)<\/p>\n Okay, But What the Heck is Programmatic Equity?<\/strong><\/p>\n As Sam explained to me,\u00a0“Programmatic equity<\/strong><\/em> is where we provide a facility of capital, say $25 million to $50 million of committed capital, for a particular strategy that a sponsor is pursuing.”<\/p>\n Example:<\/strong><\/p>\n Let’s\u00a0suppose that a developer specializes in buying large, older, mobile home parks,\u00a0and then the developer repaves all of the streets, tears out the\u00a0landscaping and puts in far-nicer lawns and bushes, puts\u00a0in a new\u00a0pool and a new clubhouse, enforces the park rules about skirts and storage sheds, squeezes out the mobile homes being used as rentals, squeezes out the ugly and\/or single-wide coaches, and then dramatically raises the\u00a0rent.<\/p>\n When everything is stabilized, the developer then sells the mobile home park to a REIT. \u00a0This is his program<\/strong><\/em>. \u00a0He has flipped four parks already, and he has identified fifteen other parks in need of his program. \u00a0He needs just $3 million in equity to satisfy each bridge lender providing the underlying\u00a0first mortgage, but in order to renovate all fifteen parks, he might eventually need a total of $45 million in equity.<\/p>\n A provider\u00a0offering programmatic equity might go all the way down to just $3 million on each mobile home park\u00a0because the sponsor will be doing 15 of these projects. \u00a0 The provider might\u00a0offer the developer a capital facility<\/strong><\/em> (kind of like a line of credit) of $30 million in equity to start\u00a0renovating these large, old, mobile home parks.<\/p>\n By George Blackburne<\/p>\n","protected":false},"excerpt":{"rendered":" A company named JCR Capital sent me an email flyer several months ago advertising their equity capital for value-add 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