A Novel Solution to the Commercial Real Estate Problem

The Financial Times has an article about one group’s plans to refinance commercial real estate. Their plan is to not refinance all of the maturing debt with more debt. They plan to use equity.

The idea is to refinance existing CRE with equity raised via a REIT vehicle. The REIT would hold title to the properties but the current owner would continue to operate the properties. The owner would pay the REIT a dividend from property cash flows which would be passed onto the REIT shareholders. The article suggests that shareholders would receive something in the neighborhood of 5% to 7% on their money plus an inflation premium which would be based on the local rental inflation index.

A successful owner/operator would keep any rents above the inflation adjusted dividend but would lose the property if he was unable to maintain the dividend. The REIT would receive 20% of the profits from the sale of the property and the owner would keep the remainder.

Given that there is for all practical purposes no market for CRE debt or at least only one that is prohibitively expensive, this structure has some merit. In fact, even if there were a market, the idea has merit. Rather than trying to squeeze excessive profits out of piece of real estate by taking excessive risk via debt financing, the REIT structure settles for more predictable and far less risky cash flows.

I suspect that at this point in time there are more than a few investors that would settle for an inflation protected return of the magnitude forecast here if it also involved a slice of future sales proceeds. There’s also little reason why some very modest amount of leverage couldn’t be employed to boost the return somewhat.

It will be interesting to see if this plan can survive with healthy debt markets. From an owner’s standpoint there is a lot to like about it but the returns that accrue through leverage are hard to ignore. I suspect that human nature and greed dictate that leverage wins out.

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About Tom Lindmark 401 Articles

I’m not sure that credentials mean much when it comes to writing about things but people seem to want to see them, so briefly here are mine. I have an undergraduate degree in economics from an undistinguished Midwestern university and masters in international business from an equally undistinguished Southwestern University. I spent a number of years working for large banks lending to lots of different industries. For the past few years, I’ve been engaged in real estate finance – primarily for commercial projects. Like a lot of other finance guys, I’m looking for a job at this point in time.

Given all of that, I suggest that you take what I write with the appropriate grain of salt. I try and figure out what’s behind the news but suspect that I’m often delusional. Nevertheless, I keep throwing things out there and occasionally it sticks. I do read the comments that readers leave and to the extent I can reply to them. I also reply to all emails so feel free to contact me if you want to discuss something at more length. Oh, I also have a very thick skin, so if you disagree feel free to say so.

Enjoy what I write and let me know when I’m off base – I probably won’t agree with you but don’t be shy.

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