Use My Equity
How owners can put unused or underused equity to work in a sound transaction, receive different benefits, and remain passive without first making an outright cash sale.
By Darryl McCullough and Alejandro Duque8 min read
FIRST PUBLISHED JULY 2019; EDITED FOR WEB READABILITY.
How often do you wonder about the added yield potential of the free-and-clear property or other equity sitting dormant in your portfolio?
Developers, investors, and business owners, whom we will call the Sponsor, are often short on the capital needed to fund a quality deal. A bank or other lender may be interested, yet still require additional collateral, credit enhancement, or more income for debt service before it will close.
The marketplace has a tried-and-true way to raise that capital, though not in the conventional form. A great deal of unused equity is already sitting in real estate, notes, businesses, and other assets. When the people and the transaction fit, some of that equity can be put to work.
Why would an owner participate?
An owner who is content with a free-and-clear property may still want to improve yield, change benefits, separate a partnership, reduce management, or put an underused asset to work. In this paper, we call that owner the Provider.
As a passive financial partner, the Provider may use an asset through a joint venture, a loan or pledge of title, an asset exchange, or a mortgage created against the asset.
In return, the Provider may receive shares in the Sponsor's development, a mix of cash and shares, income-producing paper such as a mortgage or preferred shares, an asset class that fits better, or another agreed benefit that works for the people involved.
The idea travels across asset classes
The concepts remain consistent whether we are dealing with a small residential lot or a multinational company's head office. Think across the portfolio: cash, mortgages and notes, vacant land, homes and condominiums, office and retail, multifamily and assisted living, mobile-home communities, hotels and motels, mini-storage, campgrounds and RV parks, farms and ranches, recreational property, business interests, and other real or personal property.
A necessary caution
Creativity does not replace sound due diligence by every party. The goal is for all participants to come away with better benefits than before. A creative structure may also require additional tax planning and legal review before anyone signs.
Examples from real transactions
Through direct involvement and observation, we have seen this formula close in many forms:
- A free-and-clear land parcel secured a seller take-back second mortgage for part or most of the down payment on an income-property sale. The conventional lender would not allow a second mortgage on the property being purchased, so the off-site collateral allowed the buyers to close.
- Buyers pledged raw development ground as credit enhancement to win a bank loan and cover some seller financing to buy a mid-sized company.
- A Sponsor borrowed a Provider's asset for a short period as added collateral. After long-term financing closed, the Provider's property was released back.
- Free-and-clear equity supported a lease/option. After rehabilitation and new financing, the collateral was released.
- A blanket mortgage covered the property being acquired and off-site equity. Negotiated performance criteria allowed partial releases of the additional security.
- A no-money-down buyer acquired a hospitality property with partial bank financing and a seller who took a safe off-site first mortgage.
- A Sponsor had sold one property with a long closing and found a replacement owned by a Provider. To close quickly, the Sponsor gave the Provider a safe first mortgage on the original property in exchange for the deed to the replacement property.
- A Provider owned development property but had neither the interest nor expertise to develop it. The Provider transferred title to a new company jointly owned with a qualified Sponsor, with a safety-first position for the Provider.
- A passive lender had foreclosed on property it did not want to develop. Through a Provider, the Sponsor offered the lender a larger, safe first mortgage on a separate approved property in exchange for free-and-clear title to the foreclosed property plus additional lender cash. The Sponsor received the land and development cash. The Provider kept its free-and-clear property, created the passive low-interest-rate first mortgage, and received a higher-return joint-venture position with the Sponsor. The lender converted a problem property and available cash into a comfortable debt position.