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Tips for Enticing Equity Participation

May 25, 2012 | Comments: 0 | Views: 151

The most common funding structure for real estate development projects involves a combination of equity participation and debt financing. Some form of equity is required from the developer as a deposit to the lender in order to finance the deal. It's not common for developers to fund their projects entirely from their own cash reserves. In fact, in order to mitigate risk, developers often seek equity participation from sources other than their own cash reserves or other assets. A wide variety of strategies exist to entice equity sources to invest and participate in a real estate development project. Understanding how and where to find and secure equity participation can be the difference between financing and failing to finance a promising real estate development project in today's market.

There are various key elements that are critical for project funding, including, a) Appropriate location, b) Suitable design, c) Strategic development plan, d) Feasible financial pro forma, e) Viable market study, f) Effective marketing/sales plan, g) Strategic deployment strategy, h) Comprehensive operations strategy, i) Expertise of the development team, and others. Pristine documentation of these key elements help create a more "financeable" development package for the lender; However, without the appropriate equity in place for the project, excellent documentation and expertise may be irrelevant for financing purposes. Simply put, a great plan, excellent documentation and even high-level expertise are not sufficient to obtain financing by themselves, but they must be coupled with appropriate equity to effectively meet the financing requirements of lenders in today's challenging economy.

The recent decline of economic conditions, limited availability of credit, devaluation of properties, and general decrease of real estate development loans throughout the United States has created the need for a high level of financing creativity to effectively structure the funding of real estate development projects in today's market. Equity can be provided in a variety of forms, including cash investments, property, equipment and professional services. A creative developer can piece together the equity requirements of the lender by obtaining equity participation from external sources, including:

· Equity investors

· Professionals such as architects, engineers, attorneys and consultants

· Equipment suppliers

· Brokers

· Land owners/sellers

· Municipalities

· Government entities

· Local businesses and professionals

Equity arrangements are typically structured using contractual agreements between the developer and the parties that contribute equity to the project. In a common scenario, the developer offers some type of benefit or incentive to the equity provider in exchange for their equity contribution. Following are several examples of such arrangements:

· The landowner contributes the property to the project in exchange for a percentage of ownership in the project, or a profit-sharing arrangement that takes place after the project is completed. The property is used as equity for the project, and the lender is able to place a mortgage on the property to secure its position.

· The project architect contributes all construction design work, engineering work, and permitting services in exchange for double the cost of the work, to be paid from project proceeds after the project is completed. The value of the completed work is accepted as equity by the lender because this would otherwise be a cost to the project. The incentive to the architect is the ability to double his fees by becoming a partner in the deal.

· A municipality provides a TIF bond for the project. The bond can be assigned to the lender and used as equity for the loan. The benefit to the municipality is the creation of temporary and permanent jobs, aesthetic enhancement of the area, and increased economic activity that will take place following completion of the project.

· A local business owner provides a cash investment to the project in exchange for an agreed percentage of ownership in the deal. Future value and projected revenues are the benefit to the business, in exchange for cash that is needed by the project for financing purposes.

These are merely a few examples of common equity contribution arrangements by external parties who become associated with real estate development projects, and assist in the financing process. A creative developer is able to formulate and implement effective strategies for presenting and proposing the equity investment opportunity to prospective parties in order to entice their participation. Following are tips for accomplishing this objective:

Tips for enticing equity participation for real estate development projects:

1) Prepare a professional real estate development plan for your project, or have a professional prepare it for you.

2) Prepare an intricate financial pro forma that provides a concise summary of the uses and sources of funds, funding structure and operating statement; but also provides elaborate details in the following pages. Your financial pro forma should be conservative, credible and show reasonable profitability and return on investment over time.

3) An effective market/feasibility analysis is necessary to demonstrate the demand and economic viability of your project based on demographics, statistical data, market trends and other factors.

4) Letters of support from the local municipality, other government entities, local businesses, business organizations, and community organizations can help add validity to your concept for the proposed real estate development project.

5) Prepare a professional multimedia presentation outlining the strengths and benefits of the project, and describing the equity investment opportunity.

6) Prepare all investment documentation for equity investors, including an equity investment agreement, partnership agreement, subscription document, prospectus, etc. Your attorney should assist in this area to ensure that SEC laws are complied with.

7) Invite prospective equity investors to a presentation meeting by sending a professional letter describing the highlights of the opportunity. Follow up by phone and/or email.

8) Meet with equity investors privately to negotiate a specific arrangement with each one based on their individual equity contribution for the project. Have all documentation ready for the investor's review and signatures.

The rest is up to you. Your enthusiasm, professionalism, expertise, and ability to elaborate the strengths of the project while demonstrating how you will overcome the challenges of the project are important factors for enticing equity participation. If this is not your strength you may consider working with a consultant or other professional that can help in this area.

It is important to demonstrate the real benefits of your proposed equity investment opportunity to equity investors; how they will profit from their equity participation in the project; and all other ancillary benefits that can be advantageous for them and/or their businesses (such as the enhancement of the community, new jobs in the area, increase of economic activity in the area, etc.). If your project is feasible, can demonstrate profitability, development and management expertise, and is properly documented; then there is no reason why you shouldn't be able to entice the equity participation that will leverage the financing needed for your real estate development project, even in a challenging economy.

Author: Ricky Trinidad, Metronomic, Inc.

Note: Ricky Trinidad is a manager for Metronomic, Inc. a planning, development and financing consulting company with offices in Schaumburg, IL, Chicago, IL and Miami, FL.

Feel free to contact Metronomic for a free review of your project and to see what resources we may be able to provide in your efforts.

Web: Email:

Source: EzineArticles
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