This article is part of our passive investors guide on real estate syndications, available here.
Recapitalization happens when a sponsor decides to refinance a current asset or looks to bring in new investors with either new debt or new equity and, in some instances, without losing controlling interest. It’s a great way to maintain the capital structure’s value and ensure that the sponsor has enough capital raised to fully perform the business further or even potentially buy out all or a portion of the investors.
For the recapitalization of a company’s equity, the target company can benefit from an updated equity mixture in its financial structure that can alleviate the company’s debt, increase the tax-deductible, prevent a hostile takeover, or maintain its share price.
The best part of recapitalizing any real estate property is that there is limited risk in these transactions because the sponsor already has a solid knowledge base on the asset.
In this article, we’ll look at multifamily real estate recapitalizations and what you should be looking for in a recap.
What Does Recapitalization Mean in Real Estate?
A recapitalization in real estate is when a real estate investor decides to restructure the debt or equity by bringing additional investors who either sit in a debt or equity position in the capital stack. You can easily recapitalize any property you own, provided you go about it correctly and get enough investors on board. When it comes to recaps, you must ensure that the money raised is enough capital to provide a suitable investment vehicle for investors.
If you raise capital for an existing property, there is a lower risk profile for new investors looking to invest in the property, which is why they will be more likely to invest. It’s an effective tactic used by investors to undertake investments that can reap plenty of rewards for investors. Part of why a sponsor would choose to recapitalize a property is because they want to further upgrade the property, provide a return of capital to investors, or buy them out.
To provide you with a better understanding of recaps, let’s take a look at the next section, where we dive into equity recapitalization and the capital structure.
Equity Recapitalization and Capital Structure
Re-structuring the capital stack or capital structure is a crucial part of the balancing act for a real estate sponsor. The company’s capital structure comprises multiple pieces: senior lenders in the first position, junior lenders in the second position, mezzanine lenders, preferred equity investors, or common equity investors, to name a few.
A real estate sponsor may want or need to raise more capital for a specific reason, like increasing or to maintain liquidity, or to raise more capital to acquire more assets, or maybe simply wanting to swap out some partners who are troublesome or want out. Whatever the case, the sponsor can recap the capital structure by selling off a portion of their interest in the project to recapitalize the equity stack of a given property.
When sponsors understand a property completely, they are in the best position to evaluate and understand the risks associated with its investment. That’s why some investors prefer to invest in the safety of an already precedent-established asset instead of a new acquisition.
Refinancing vs. Recapitalization in Multifamily
Refinancing is replacing an existing debt on a property with new debt. A sponsor might do this to have more favorable interest rates, better loan terms, provide more capital for the project, or maybe to return capital to investors.
In the context of a multifamily property, refinancing is the restructuring of debt in a multifamily project, while recapitalizing a multifamily property is the re-structuring of both debt and equity.
An Example of a Recapitalization in a Multifamily Deal
Let’s say we’ve owned a 120-unit garden-style apartment community in Atlanta for 4 years. We completed the value-add renovation schedule in month 18 of owning the project and then proceeded to refinance the property. But since that refinance in month 18, the property has significantly appreciated due to market conditions. Let’s say the property is now worth $10,000,000, and our existing in-place loan is for only $5,500,000.
Let’s say that the real estate sponsor of the project owns about 40% of the deal; they may choose to recapitalize the equity by selling, say, 20% of their shares at a fixed price. To keep the numbers as clean as possible, upon selling the equity, the sponsor may get a check for roughly $1,800,000, which they can now use for various things.
They may use it to increase their liquidity to keep good strength as a borrower in the eyes of a future lender. They may use those funds as a down payment on the next acquisition or maybe use it to hire high-end talent to facilitate the firm’s growth, all further while still having a 20% upside in the future value of the project.
Frequently Asked Questions About Recapitalization Real Estate
The purpose of a successful recapitalization is to re-structure the capital stack of a given project to meet the new needs of the partners in a project or to take advantage of the value appreciation of the asset.
Recapitlziing a loan simply means bringing in new debt securities to take out the existing in-place debt. There could be a multitude of reasons why one would recapitalize a loan. Most commonly, it’s because the borrower feels they can get better loan terms, better interest rates, lower prepayment penalties or higher LTVs. Another common reason could be the debt burden that may force the borrower to recapitalize the loan, as perhaps the existing loan is coming due.
Real Estate Recapitalization – Conclusion
Recaps are a great way to leverage the private equity in a multifamily property to swap out a portion of the existing limited partners with new limited partners. It’s also a great way to swap out old debt with new debt, providing a small to large liquidity event for investors.
It’s always good to understand the reason the sponsor is looking to perform a recap to get the complete picture of the opportunity that lies at hand. If you’re interested in learning more about private multifamily investing, join the investor club to get our exclusive resources and see our upcoming private investment opportunities.
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