Dequity: A Debt, Equity And Capital Markets Explanation
"Dequity," a portmanteau making its rounds in the commercial real estate world, was the buzzword of choice at a recent Bisnow event where the topic du jour was a question plaguing many in CRE these days: How do I finance my project?
As the communications channel for the commercial real estate industry in the U.S. and UK, Bisnow keeps its ear to the ground when it comes to the latest terminology in the industry. So we made it our business to learn about "dequity" and what it means to CRE.
A marriage of "debt" and "equity," which are generally regarded not quite as opposites, but certainly distinct financial terms, this new word is a head-scratcher at first. But a peek beneath the surface unveils its familiarity as well as its utility.
What is “dequity”?
In CRE finance, dequity is a spectrum of investment structures that have the attributes of both debt and equity, sitting squarely between the two. Borrowers don't go to lenders looking specifically for dequity, but often find its precisely what they need to make their capital stack work.
Instead, they are looking for something to plug the gap between what they can borrow outright and the equity they are willing and able to bring to the table. That gap can be quite wide, and can be bridged in a number of ways, such as with preferred equity, mezzanine debt, A/B loans, subordinated debt and so on.
None of those financing structures is new, are they?
Not at all. What seems to be new is the real estate industry classifying them as part of an umbrella called “dequity,” which can be thought of as a spectrum of alternative financing — again, that sit between debt and equity. Some of the structures are closer to debt, others closer to equity. Use a combination of these in a given deal and that can be thought of as dequity, since the deal thus has elements of both.
These financing structures themselves can have elements of both debt and equity as well. For example, preferred equity is paid before common equity, a classic attribute of debt. On the other hand, convertible debt has a strike price that can be converted, when it hits that price, into an equity position.
So it's a new term?
Nope. Georgette Chapman Phillips, dean of the College of Business at Lehigh University, published a paper in 2005 describing dequity in detail. She doesn't claim to have invented the term, or the concept, but she certainly was an early user of it.
The concept was fairly new at the time, since one change in capital markets in the 1990s — at least regarding CRE — was lenders' increasing reluctance to finance as much as the traditional 90% of the deal, the norm at the time. In the new millennium, with the rise of CMBS and other new forms of lending, 65% became more standard. But although dequity dates back nearly 20 years, it seems to be having its moment now.
That isn't entirely clear, but these are strange times in the capital markets. The deals getting done require more creative structures than ever.
During the long period of low interest rates, when financing was relatively easy and CRE markets were relatively strong, no one worried as much about which financing products were more “equity-like” and which more “debt-like.” When everyone is getting paid, everyone is happy. That isn't the case any more, so perhaps CRE is paying much more granular attention to deal structures. New terms tend to appear when markets need them.