This article was originally published in the September 2016 issue of Western Investor, a trusted source for commercial real estate, franchising and business opportunities in Western Canada.
Although interest rates are at historical lows, there are still places banks are reluctant to go. When it comes to commercial real estate, banks typically require a minimum investment which ranks behind, or subordinate, to the bank. The challenge faced by certain real estate developers is finding alternate sources of funding to fill the gap between traditional equity and traditional debt.
This is the world of alternative real estate financing. There are a host of alternative financing models out there, but two commonly cited options are mezzanine financing and crowdfunding. From a legal standpoint, these are both viable options for injecting additional funding into a commercial real estate project, however it is crucial that the developer have a clear understanding of what is this alternate funding method is and the associated risks.
Mezzanine financing¸ also known as “subordinated debt” or “participating debt”, is a financing model which allows an owner to obtain additional funding where it is unable to or does not wish to increase the equity invested in the project, and traditional financing has been maxed out. The mezzanine lender has a higher level of risk than the traditional lender, and this added risk is usually balanced by a higher rate of return payable to the mezzanine lender, though these returns may be deferred or reduced during the initial stage of the project.
Whether or not mezzanine financing is appropriate for a particular investment depends on a number of criteria. Given the added risk, most mezzanine lenders will look for an established business with a solid cash flow. However, in a growing economy, mezzanine lenders may be prepared to accept less certainty in exchange for higher returns based on the success of the project, such as a percentage of revenues, bonus fee payments, or options to convert debt into (or acquire) an equity interest in the project.
Working with a mezzanine lender can offer a flexible way of obtaining additional funds for proposed real estate development, where traditional funding options have been exhausted or tapped out.
Crowdfunding has actually been around for many years. However, it has come into its own in the age of social media as a means of funding everything from the latest inventions, gadgets and video games, to political action committees and real estate developments.
With the introduction of the Start-Up Crowdfunding Exemption in 2015, the BC Securities Commission recognized crowdfunding as an alternative source of investment capital for certain types of businesses. Within the scope of this exemption, start-up companies are able to raise small amounts of private funds without being required to file a prospectus. While there are a number of rules and regulations which must be complied with and limitations on the amount which can be raised (currently a maximum of $250,000 twice per calendar year), crowdfunding is an alternate way which a potential commercial real estate developer may be able to obtain the necessary funds to satisfy the equity and junior debt requirements of the traditional lender.
To date, public response to crowdfunded commercial real estate offerings in Canada has been less than enthusiastic. This may be a function of the fact that traditional debt is available historically low rates, and other sources of raising capital are also readily available. On the other hand, crowdfunded real estate investment is still relatively new in Canada. As the process becomes more widely known, response to these types of offerings may increase.
As noted above, there are a number of other alternative financing models in addition to mezzanine financing and crowdfunding. When seeking alternate sources of funds for a commercial real estate development project, it is important to ensure that the financing model meets with the objectives for the project.
As always, having an experienced legal advisor who can assist in assessing the various options and providing advice on how to best structure the project is invaluable.
Peter J. Anderson is a partner at Boughton Law, and has a solicitor’s practice focused on commercial real estate.