Structured Finance, What Is It and How Can You Benefit From its Use? Commercial Real Estate Investment Bank, Pacific Security Capital, Reveals Your Options

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Pacific Security Capital exposes structured finance and reveals the options available for commercial real estate borrowers.

http://www.pacificsecuritycapital.com -- Pacific Security Capital (“PSC”), a leading commercial real estate investment bank, headquartered in Beaverton, Oregon, reveals how commercial real estate borrowers can benefit from structured finance.

Mike Myatt, Executive Managing Director of Pacific Security Capital, explains that “there is no longer a clear division between debt and equity in the commercial capital markets. Given the ever increasing complexity of financially engineered structured finance solutions it is essential for borrowers to develop a detailed understanding of the capital markets and the structured finance options available to them.”

The optimized use of structured finance solutions is one of the few arenas that allow commercial real estate owners to dramatically impact leverage, efficiencies and economies of scale across all business lines including acquisitions, financing ventures and operating activities.

Structured finance is best defined as financially engineering the proper blend of debt, equity, synthetic, derivative and hybrid capital in order to resolve particular transactional needs that cannot readily be met by conventional senior financing.

Structured financing allows for an engineered design and pricing of situation-specific financing instruments. Representative examples of typical situations that call for structured finance solutions include the following:

  •     Working around balance sheet or capital constraints;
  •     Shifting a higher percentage of the capital structure down in the leverage curve;
  •     Attaining greater amounts of leverage at a lower blended cost of capital;
  •     Adding value and increased leverage to buyouts, yield-plays, recapitalizations, repositionings, stress-induced financial restructuring, and arbitrage-driven hybrid debt or synthetic funding;
  •     Shifting risk and better managing control at both the project and entity levels;
  •     Releasing trapped equity in single assets or portfolios;
  •     Conversion of illiquid assets into tradable securities;

While many would choose to define structured finance in narrow terms it is rather the limitless ability to engineer hybrid, synthetic or derivative instruments that makes the engineered solution provided by structured finance so valuable. Typical structured finance instruments include the following:

  •     Senior and Junior Mezzanine Debt;
  •     Straight, Convertible and Participating Second Mortgages;
  •     Pari-Passu or Preferred Equity Structures;
  •     Bond Placements, Tax Credits and other Municipal Finance Alternatives;
  •     Collateralized Mortgage Pools, Collateralized Debt Obligations and other Credit Derivatives;
  •     Index or Currency Linked Strips;
  •     Swaps, Options, Caps, Collars, Swaptions, Captions, etc;
  •     Credit Enhancement, Financial Guaranties, Standby Commitments; Forward Commitments;

Mr. Myatt, explains, “understanding how to maximize all levels of the capital structure through the use of structured finance techniques when developing the capital formation plan on your next transaction will help you create a much more effective and efficient execution.” The following items are just a few of the benefits of understanding how to engineer the right capital structure:

1.    Use all levels of the capital structure to move up the leverage curve: By using the proper combination of senior debt, subordinated debt and third party equity it is possible to realize leverage well in excess of 90% of the total project cost or value while maintaining control of the investment.

2.    Use different levels of the capital structure to prevent project ownership dilution: By using mezzanine financing to fill as much of the equity gap as possible you will lower your overall cost of capital while not being forced to give up as much ownership in the project as you would by closing the entire equity gap with a joint venture equity partner.

3.    Negotiating the proper type of equity joint venture can be critical to the financial success of a project: If you move up the leverage curve with the proper combination of senior and subordinate debt the amount of equity needed from outside investors is minimized. Using the right pari-passu, or preferred equity investment structure can leverage the sponsor co-invest to as little as 2% -5% of the project equity requirement while still leaving the sponsor with the majority of project ownership.

4.    Individual Investors vs. Institutional Investors: Decide early where you choose to seek your capital partners and investors and be willing to live with your decision. With rare exception if a sponsor can meet institutional suitability tests they will be better served by accessing commercial capital markets rather than dealing with individual investors. Institutional investors have more knowledge and flexibility when structuring transactions giving owners more operating flexibility.

Institutional investors have deep pockets and can provide the appropriate level of financing to allow sponsors to engage on multiple projects at one time thereby creating the ability to grow their business with greater velocity when contrasted to the leverage provided by individual investors. Additionally most institutional investors prefer passive investments and will only exercise dilution or control provisions in the rarest of circumstances. Lastly, institutional investors often times can provide tremendous non-financial value adds in the form of knowledge base, intellectual capital, market contacts and the like.

5.    Resist the temptation to do “one-off” project level financings: Disparate financings at the project level can at a minimum restrict a borrowers future ability to cost effectively monetize on value creation by subjecting the property to pre-payment issues in the case of refinancing or disposition prior to the expiration of lock-out periods. Worse than trapping equity at the project level may be the fact that one-off financings restrict the ability to pool the asset with the balance of the portfolio creating a lack of optimized leverage and timely access to credit which in turn can create capital constraints by slowing acquisitions activities or operating initiatives.

Lastly, large portfolios or even smaller sub-portfolios created by a multitude of one-off financings can create a management nightmare. This is due to constantly maturing debt rollover which will subject individual assets to credit, interest rate and market risk. This type of risk is not present when financing at the portfolio level due to the ability to trade in and out of collateralized pools where pricing, sizing and structural aspects are known constants.

Understanding how to access and maneuver within the commercial capital markets and effectively leveraging the many benefits of structured finance techniques can be the defining difference in optimizing the scalability and efficiency of your commercial real estate venture.

About Pacific Security Capital

Pacific Security Capital is a leading commercial real estate investment banking firm providing commercial real estate loans, structured finance, investment sales and advisory services. The combination of direct lending, advisory, intermediary, corporate and professional services, syndication and acquisition services consistently allow PSC to rank among the leaders in the industry. PSC is headquartered in Beaverton, Oregon with other offices in major markets in North American and Europe. More information about the company can be found at http://www.PacificSecurityCapital.com.

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Lee Odden
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