Tighter loan standards for banks have opened up the market for alternative financing. Nontraditional lending sources benefit from less regulation and a greater variety of incentives to match projects across multiple asset classes. Real estate construction reached $1.11 trillion in 2015. To keep pace with growth, developers often have had no choice but to turn to alternative forms of financing.
Baker Tilly Capital partner Michael Fitzpatrick and principal Aaron Goforth help clients navigate programs like EB-5 and New Market Tax Credits, finding the best fit and price point for their projects. As bank loans become harder to acquire, developers look to Fitzpatrick and Goforth as guides to understanding alternative options and the varied requirements needed to fill the gap in their capital stacks.
Think you know the ins and outs of alternative financing? Take this quiz from the Baker Tilly specialists and test your knowledge.
1
Which of the following is an example of alternative financing?
YOU'RE CORRECT!
Alternative financing sources run the gamut from government-backed programs to private investors funding projects with mezzanine debt or equity. EB-5, an investment program created in the 1990s by Congress to encourage foreign investment, grew in popularity after the 2008 financial crisis. Under the program, foreign investors can gain a permanent residence visa by investing in a U.S. commercial enterprise that either creates or preserves 10 permanent full-time jobs.
Other programs appeal to specific project types and geographic locations. New Market Tax Credits offer financing for development in distressed communities, and Historic Preservation and Low Income Housing Tax Credits, respectively, support affordable housing and older building stock. Property Assessed Clean Energy (PACE) is an initiative legislated at the state level that provides loans for energy efficiency and renewable energy projects in commercial buildings.
Baker Tilly focuses on financing sources like EB-5, NMTC, HTC and a wide range of tax credit incentive programs at the federal, state and local levels.
YOU'RE WRONG!
Alternative financing sources run the gamut from government-backed programs to private investors funding projects with mezzanine debt or equity. EB-5, an investment program created in the 1990s by Congress to encourage foreign investment, grew in popularity after the 2008 financial crisis. Under the program, foreign investors can gain a permanent residence visa by investing in a U.S. commercial enterprise that either creates or preserves 10 permanent full-time jobs.
Other programs appeal to specific project types and geographic locations. New Market Tax Credits offer financing for development in distressed communities, and Historic Preservation and Low Income Housing Tax Credits, respectively, support affordable housing and older building stock. Property Assessed Clean Energy (PACE) is an initiative legislated at the state level that provides loans for energy efficiency and renewable energy projects in commercial buildings.
Baker Tilly focuses on financing sources like EB-5, NMTC, HTC and a wide range of tax credit incentive programs at the federal, state and local levels.
2
What is the recommended minimum size project for EB-5?
YOU'RE CORRECT!
Developers interested in EB-5 funding typically work with a regional center to ensure the development can benefit from the direct, indirect and induced jobs associated with the project. EB-5-eligible job creation determines how much EB-5 capital can be placed in a project. Because of the close oversight from the United States Citizenship and Immigration Services (USCIS) and other regulators, EB-5 is sophisticated and approaches an institutional-level source of funds, Goforth said. Project size has to be scaled for the deal to remain profitable, and Fitzpatrick and Goforth work with clients to determine the best fit.
Costs increase when developers engage professionals to prepare necessary reports and an attorney to draft securities and immigration documents. Hiring a third party to raise money through foreign immigration consultants also raises the cost of EB-5 financing. According to Goforth, $5M in EB-5 financing would be the minimum funding amount worth the effort. Because EB-5 makes up 30% to 40% of a capital stack, the project would have to be $15M and over.
Scale plays a factor in determining which alternative financing program works best. For projects like Hudson Yards, a 10-year, $20B mixed-use development, building an in-house regional center and EB-5 financing team makes sense.
"Hudson Yards is a large project where it makes sense to internalize a lot of the financing functions, but smaller projects can also benefit from these programs by working with established regional centers that serve third-party projects,” Fitzpatrick said.
YOU'RE WRONG!
Developers interested in EB-5 funding typically work with a regional center to ensure the development can benefit from the direct, indirect and induced jobs associated with the project. EB-5-eligible job creation determines how much EB-5 capital can be placed in a project. Because of the close oversight from the United States Citizenship and Immigration Services (USCIS) and other regulators, EB-5 is sophisticated and approaches an institutional-level source of funds, Goforth said. Project size has to be scaled for the deal to remain profitable, and Fitzpatrick and Goforth work with clients to determine the best fit.
Costs increase when developers engage professionals to prepare necessary reports and an attorney to draft securities and immigration documents. Hiring a third party to raise money through foreign immigration consultants also raises the cost of EB-5 financing. According to Goforth, $5M in EB-5 financing would be the minimum funding amount worth the effort. Because EB-5 makes up 30% to 40% of a capital stack, the project would have to be $15M and over.
Scale plays a factor in determining which alternative financing program works best. For projects like Hudson Yards, a 10-year, $20B mixed-use development, building an in-house regional center and EB-5 financing team makes sense.
"Hudson Yards is a large project where it makes sense to internalize a lot of the financing functions, but smaller projects can also benefit from these programs by working with established regional centers that serve third-party projects,” Fitzpatrick said.
3
How can alternative financing optimize the capital stack?
Fill a gap in the capital stack
Reduce the overall cost of capital
Offer nontraditional terms
YOU'RE CORRECT!
When fundraising for a project, developers often have a gap in their capital stack between their equity and senior debt. As banks and institutions become more stringent with lending, those gaps have widened. Developers can sell securities in private placements to investors with high net worth, but those investors will often demand a higher interest rate and a greater stake in ownership.
"Regulation D private placements to high net worth individuals is an expensive source of funds,” Fitzpatrick said.
Alternative financing allows developers access to less expensive funds without diluting their equity.
YOU'RE WRONG!
When fundraising for a project, developers often have a gap in their capital stack between their equity and senior debt. As banks and institutions become more stringent with lending, those gaps have widened. Developers can sell securities in private placements to investors with high net worth, but those investors will often demand a higher interest rate and a greater stake in ownership.
"Regulation D private placements to high net worth individuals is an expensive source of funds,” Fitzpatrick said.
Alternative financing allows developers access to less expensive funds without diluting their equity.
4
How much did the U.S.' alternative finance market grow in 2016?
YOU'RE CORRECT!
Alternative financing volume in the U.S. totaled $34.5B in 2016, according to a joint report from The University Cambridge and The University of Chicago. Once developers figure out the process for alternative financing, they are often return customers, Goforth said.
"Many alternative financing programs are less expensive sources of capital and highly flexible,” Fitzpatrick said. "They typically can be structured as subordinated debt, and have the benefit of filling a gap in the capital stack between senior debt and equity in order to get projects done."
YOU'RE WRONG!
Alternative financing volume in the U.S. totaled $34.5B in 2016, according to a joint report from The University Cambridge and The University of Chicago. Once developers figure out the process for alternative financing, they are often return customers, Goforth said.
"Many alternative financing programs are less expensive sources of capital and highly flexible,” Fitzpatrick said. "They typically can be structured as subordinated debt, and have the benefit of filling a gap in the capital stack between senior debt and equity in order to get projects done."
5
What is the advantage of New Market Tax Credits?
Regulation under Dodd-Frank
It can make up 45% to 50% of a capital stack
It is an entitlement program
YOU'RE CORRECT!
Developers working in qualified low-income communities can receive inexpensive and flexible funding through the NMTC Program from Community Development Entities (CDEs). CDEs have the authority to monetize NMTC to make a loan to a qualifying business or real estate project. NMTC offers lower interest rates, subordinated debt, interest-only terms, lower origination fees, higher loan-to-value ratios, lower debt coverage ratios and longer maturities.
"NMTC is probably one of the most advantageous forms of alternative financing, because it can fill 20% to 25% of the capital needs of a project, and a portion of that is designed to be permanently retained by the project after a seven-year compliance period,” Fitzpatrick said.
NMTC is not an entitlement program. There is a finite amount of NMTC available annually, and projects must compete on the basis of community impact to receive funding.
YOU'RE WRONG!
Developers working in qualified low-income communities can receive inexpensive and flexible funding through the NMTC Program from Community Development Entities (CDEs). CDEs have the authority to monetize NMTC to make a loan to a qualifying business or real estate project. NMTC offers lower interest rates, subordinated debt, interest-only terms, lower origination fees, higher loan-to-value ratios, lower debt coverage ratios and longer maturities.
"NMTC is probably one of the most advantageous forms of alternative financing, because it can fill 20% to 25% of the capital needs of a project, and a portion of that is designed to be permanently retained by the project after a seven-year compliance period,” Fitzpatrick said.
NMTC is not an entitlement program. There is a finite amount of NMTC available annually, and projects must compete on the basis of community impact to receive funding.
6
What is a risk associated with alternative financing?
Regulation under Dodd-Frank
YOU'RE CORRECT!
While often complex and challenging to access, alternative financing appeals to developers for flexible and affordable loans, but knowing which program is right for a project can determine whether it receives funding.
“Knowing all of the different resources and tying it to the right asset class makes the most sense,” Goforth said.
Baker Tilly Capital works with clients to develop projects that not only qualify for alternative financing resources like EB-5 or NMTC but are also marketable to potential investors within those programs.
“While there are low barriers to entry, there are high barriers to achievement, as there is a wide gap between what is ‘possible’ and what is ‘marketable,’” Fitzpatrick said. "There is no point in taking an EB-5 project to market if it is not marketable. That’s part of the value-add of what we bring to the table.”
To learn more about this Bisnow content partner, click here.
YOU'RE WRONG!
While often complex and challenging to access, alternative financing appeals to developers for flexible and affordable loans, but knowing which program is right for a project can determine whether it receives funding.
“Knowing all of the different resources and tying it to the right asset class makes the most sense,” Goforth said.
Baker Tilly Capital works with clients to develop projects that not only qualify for alternative financing resources like EB-5 or NMTC but are also marketable to potential investors within those programs.
“While there are low barriers to entry, there are high barriers to achievement, as there is a wide gap between what is ‘possible’ and what is ‘marketable,’” Fitzpatrick said. "There is no point in taking an EB-5 project to market if it is not marketable. That’s part of the value-add of what we bring to the table.”
To learn more about this Bisnow content partner, click here.
