The cost of capital can have a major impact on whether or not a proposed commercial real estate investment is viable. If the cost of borrowing (the interest rate) is greater than the anticipated internal rate of return (IRR), then completing the project itself will actually generate negative value for the investor and, naturally, they will elect to pass on the project altogether.
But the cost of capital goes far beyond a simple, linear loan from a bank. In fact, with large-scale real estate investments, the so-called “capital stack” will usually contain multiple different types of financing, each structurally and financially different than the others. The different layers of the stack might include common equity, preferred equity, mezzanine debt, senior debt, and possibly other forms of financing.
Suppose you needed to raise an additional dollar for the project. Where will this additional dollar come from and how much will you effectively pay to access it? At scale, changing the rate by even a fraction of a percent can have significant financial consequences. An investor that might accept a project with a proposed 3 percent cost of borrowing might choose to pass if the marginal rate is bumped up to 3.2 percent.
Regardless, it is important to understand where your financing will be coming from. It is also important to take active steps to help minimize your overall rate. In this article, we will discuss three ways you can potentially lower your current rate.
1. Identify Your Specific Needs
There is a tremendous amount of variation within the commercial real estate (CRE) industry. The scale of the project, the qualifications, and experience of the ownership team, the location of the project, the type of property being built (office, multi-family, commercial, industrial, etc.), and other factors can all directly influence which financing options make sense for you and what rate you are likely to pay.
Rather than going into the financing process blind, it is important to have a plan. Within this plan, you should clearly define as many different components of the project as you possibly can.
- What is the proposed investment timeline?
- What is the expected rate of return?
- What type of property are you currently developing? How do you plan for this property to make money (rent, appreciation, etc.)?
- Have you, or your firm, completed similar projects in the past?
- What opportunities might help you increase the expected rate of return? What threats could potentially cause you to miss your target?
- Where will the property be located? What sorts of taxes and tax jurisdictions might apply?
Of course, these are just a few of the questions you will want to be able to answer from the very beginning of the financing process. The more details you and your team can determine in advance, the more prepared you will be.
2. Work with a CRE Finance Broker
The world of commercial real estate, especially since the passage of the JOBS Act in 2010 (enabling crowdfunding), is more accessible than ever before. But one of the most common reasons that people with capital might overlook this highly profitable investment space is that they do not want to navigate the, admittedly, complex world of commercial real estate lending.
Fortunately, there are plenty of people—like the qualified team at Lincoln James Capital—who can help you navigate this tricky lending environment. Once you have identified your specific commercial real estate finance needs, your CRE finance broker can help you compare many different financing options and help guide your loan from start to finish.
There are many different steps involved when seeing a loan come to fruition. The structuring of the capital stack, the process of comparing several different types of loans, the completion of the initial loan application, maintaining the application, and—finally—closing can all present unique challenges of their own. Even if you are, broadly, familiar with commercial real estate, working with a CRE finance agent provides myriad benefits. Your broker will help protect you from legal and financial liabilities, answer the questions you might have, accelerate the loan application process, and—most importantly—potentially lower your rate.
3. Create a Customized Loan Package
When people are interested in financing a commercial real estate project, one of the first things they will ask is, “Where can I find the best rate available?” Well, unfortunately, the answer to this important question cannot often be answered with a single word. In many cases, you will probably need to create a customized loan package in order to reduce the cost of the capital stack to the greatest extent you possibly can.
There are numerous ways in which your capital stack can potentially be “customized.” Using multiple different types of financing, distributing costs over a non-linear timeline, and borrowing from multiple different lenders (or even taking out multiple loans from the same lender) are just a few of the ways your particular loan might be modified to address your specific needs.
Once again, it becomes easy to see that knowing what you want will make the proverbial “maze” of commercial real estate finance a bit easier to navigate. However, this doesn’t mean that you need to be able to handle everything entirely on your own. Your CRE finance broker has almost certainly seen similar projects come to fruition in the past and will help put you in a position to make the financing decisions that are truly right for you. Comparing different financing options and establishing a viable capital stack are actions that are within reach.
It is impossible to promise the same “low rate” for every single project because every project will have its own dynamics at play. Time, money, experience, and project type can all affect how much you can, should, and will end up paying for financing. Nevertheless, there are still a few actions that can benefit pretty much everyone within the commercial real estate space. Knowing your needs, working with an experienced CRE finance broker, and creating a customized financing package will all put your firm in a much better position.