1,000x leverage! Turning $200,000 of seed money into a $200 million transaction

Let's explore the possibility... Many investors and developers are often deterred from larger transactions because they automatically assume that they cannot raise the capital necessary to do a nine-figure deal. This can be especially difficult in New York and other primary markets where new and creative developers have original and transformative ideas that may never be realized without access to capital. The ability to leverage a project with debt financing is often taken for granted in markets like New York where lenders compete fiercely to place capital, but there are various ways to construct a capital stack that can help investors/developers realize a project that might otherwise be unattainable. Let us walk through an example. A developer wishes to purchase a property with a $200 million price tag. In our oversimplified example, let's assume that the property's cash flow supports a loan of 70% loan-to-value, or $140 million, leaving a need for an additional $60 million. The common assumption is that the remaining $60 million must come in the form of equity from the developer This is not necessarily the case. Let us consider two examples that prove otherwise. A transaction such as this may be a strong candidate for mezzanine financing. While I use the term mezzanine, there are other forms which this capital may take, including preferred equity, a second mortgage, or even in some cases a first mortgage that can stretch to cover the portion in question. When dealing with a well located property in a strong market, the mezzanine part of the capital stack routinely reaches 80%-85%, and in many cases even goes to 90%. This means that the developer may effectively borrow up to $180 million. For the remaining $20 million of equity, the developer may choose to partner with an opportunity fund, in which the developer contributes 10% of the "sponsor equity" or $2 million, and the partner contributes the remaining $18 million. The developer can then take this one step further and syndicate the $2 million portion for which he/she is responsible (most likely through friends, family and other personal contacts) and commit to 10% of that portion, or $200,000 himself/herself. Thus the developer has successfully achieved 1,000x leverage, and turned $200,000 of seed money into a $200 million transaction. The example above is one that we have executed for clients on multiple occasions. However many clients are not comfortable with debt reaching up to 85% of the capital stack for fear of over-leveraging a property or a lack of in-place cash flow to provide the necessary debt service. In these cases we have structured a modified version of the above capital stack; forming a joint-venture partnership, where the developer is responsible for 10% of the equity requirement and a capital partner invests 90%. In the case of a $140 million senior loan, the capital partner provides $54 million ($200 - $140 million = $60 million, x 90% = $54 million) and the developer is responsible for $6 million. While this may seem like a hefty sum, the developer has several options, including a friends/family syndicate, or, a more specialized approach of partnering with a sponsor equity fund. A sponsor equity fund focuses solely on being the capital partner to developers who need help in this portion of the capital stack for which they are responsible alongside their larger capital partner. In the same spirit of the 90%/10% split on the general equity, a sponsor equity fund would commit to 90% of the $6 million that the developer needs, leaving the developer to raise only $600,000. In such a situation it must be deemed likely that if the developer is willing to commit $200,000, he or she can raise the remaining $400,000 from friends, family, etc. Thus, again, we see 1,000x leverage whereby $200,000 is used to complete a $200 million transaction. While today we are in a market where capital is plentiful, and in many cases chasing deals, the above cases, though extremely simplified and general, are also largely accurate. However, there are key factors that must be present to allow such a transaction to occur. This includes qualified and experienced sponsorship, property location and quality, and a solid the business plan for the property, which we like to boil down to "people, property, deal." As long as these three ingredients are present there are very creative capital structures that can be brought to the table. Tal Bar-Or is a managing director at Meridian Capital Group, LLC, New York, N.Y.