3650 REIT originated a trio of loans in the fourth quarter that the national portfolio lender believes represent a growing niche: providing borrowers with subordinate financing for portfolio and other large transactions.

The firm’s lending activity included a $93.5 million preferred equity financing that recapped debt on a 12-property multifamily portfolio in the southeast, with 3650 REIT taking a subordinate position behind Fannie Mae. The financing was part of a larger $1.2 billion package for a joint venture between Onyx Partners and David Werner Real Estate.

There is a need among borrowers that want to unlock trapped equity in assets that they’ve owned for years, 3650 REIT co-founder Jonathan Roth tells Real Estate Capital USA. “To monetize your investment, you can sell property and take capital off the table, or you can refinance,” Roth says. “If you refinance, there are limits with a senior loan, which will only take you up to a certain level in the capital stack.”

“ There is a school of thought where a borrower thinks, ‘I can put that capital to work at a rate that exceeds the cost of borrowing’ ”
Jonathan Roth
3650 REIT

On the Onyx Partners-David Werner deal, the excess proceeds are being used to improve the underlying assets. This is turn creates additional value, Roth notes.

Additionally, there are borrowers that want to use preferred equity or mezzanine debt to raise the leverage on larger portfolio acquisitions, as was the case with an $89 million preferred equity financing that the firm provided to RREAF Holdings for the acquisition of a 21-property, 4,000-unit residential portfolio.

“This is a structure that creates a number of solutions for borrowers in the capitalization of both new and existing assets,” Roth says. “Our excess proceeds in this particular portfolio are also being used to improve the underlying assets, with upgrades to the units.”

The financings are executed via 3650 REIT’s preferred equity platform and allow owners to pull capital out of an asset where value has already been created or could be created or simply increase the leverage level. “There is a school of thought where a borrower believes, ‘I can put that capital to work at a yield that exceeds the cost of borrowing,’” Roth says.

Putting the pieces together

Figuring out where the investment fits is part of the puzzle. Often, 3650 REIT’s ultimate decision on how to structure a financing is driven by the requirements of the senior loan. The firm typically offers leverage that get a borrower to an LTV of about 75 percent to 80 percent, Roth notes.

“If you’re behind a bank or one of the agencies, there are certain prohibitions against subordinate debt because there are leverage levels that their guidelines don’t allow them to go past,” Roth says. “By structuring a financing as preferred equity, you can live within those guidelines and still provide a solution to the borrower.”

3650 REIT sees this niche as a large area of growth, with Roth citing transactions in the pipeline that include a multifamily portfolio where the company will provide preferred equity financing to release additional trapped equity and another financing that will be subordinate to a securitized loan in connection with a value-add opportunity.

“It’s a structure that allows us to be creative and help borrowers to tap into value and take capital out of one asset and redeploy it into another,” he says.

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