If Things Fall Apart

If you get a commercial loan for a building that already exists, that building and its income stream can often be the collateral for the loan. If for whatever reason you default on the loan, the lender takes the building and starts receiving the cashflows. This is called “non-recourse” financing. The bank doesn’t need recourse to anyone’s personal assets to feel comfortable making the loan because there’s an income-producing asset behind it. But that doesn’t usually work for construction loans. If something goes wrong with a construction project, there’s no finished building with income to repossess. Performance bonds can help, but at the end of the day, lenders usually want a “personal guarantee.”

My guest in this episode is Jessica Piatt, a veteran of the banking industry who has underwritten hundreds of projects and knows the ins-and-outs of personal guarantees. She is often required to examine the personal and corporate financials of those seeking large construction loans in order to estimate their ability to cover unexpected problems with construction or lease-up. This is a world that many know of but few truly understand. I hope you take as much from the conversation as I did!

After defining personal guarantees (0:16), we discuss whether there are regulatory requirements for them (03:45). I was particularly interested to debate how guarantees affect the culture of real estate development and whether or not there would ever be a reason for lenders to forgo them (06:34). We then discussed outside guarantors (16:50), did a quick sidebar on loan committees (19:17), and returned to the meat of credit underwriting: the main documents requested by banks for guarantor analysis (24:28) and the metrics banks look for (29:04). We wrapped up with a few questions from our viewers (30:52) and a discussion of whether a bank’s requirements for guarantees are affected by the development cycle (39:37).

Getting Funded

When people need funding for a project, they often form a company, sell shares in the company, and use the money from those sales to fund their business. That’s how many real estate developers raise capital for their deals as well. They form an LLC (limited liability company) for a given project, sell shares in that company (to people who will share in the profits for that project), and use the money raised from selling shares in order to buy or build real estate. The legal document they use for this transaction is called a “PPM,” short for Private Placement Memorandum. Here’s an outstanding example of a PPM, produced by my guest’s company. In this episode we’ll be talking about this all-important system and the ins-and-outs of raising capital for real estate deals using PPMs.

My guest is Doug Ruark, whose company Reg D Resources has created over 4500 PPMs for companies of many kinds. In our chat we discussed the legal background for raising funding (00:19), the components of a PPM (7:13), the workflow for creating a PPM (18:53), getting lists of investors for 506c placements (26:54), who can actually sell the securities (29:16), selling shares as debt vs equity (38:04), whether people offer rates that are too high or too low (41:11), equity waterfalls in PPMs, which we also discuss earlier in the episode (43:37), investor audits of proceeds (46:30), and legal exposure (49:48). Hope you enjoy it!

Here are a few links to topics we discuss in the episode: overview of laws that affect securities, full-text of the Securities Act of 1933, full-text of the Regulation D exemption, the SEC’s overview of the different programs (504, 506b, and 506c), Form 1A (which is used as a questionnaire of investors for very high-grade investments), Form D (which is submitted to the SEC within 15 days of starting a raise), the SEC’s description of what a “broker-dealer” is, notes from FINRA about their Series 7 exam (required if you’re going to sell other peoples’ PPM), and an outline of the material on an exam which may be soon replacing the series 7 (the Securities Industry Essentials Test).

Twenty Million and Up

Spencer Burton has knocked on farmers’ doors looking for land deals in the Pacific Northwest, and he has built over a hundred properties in Latin America as a real estate developer. But he realized that he would be happiest if he was doing complex analysis of multi-million dollar property deals. And for that, he made his way into institutional real estate.

As Spencer explains in our chat, pension funds, insurance companies, endowments, and others such institutions, have huge piles of cash which they need to invest. They often allocate up to 10% of that cash for real estate investments. Then it falls to people like Spencer to decide what (gigantic) purchases, or even loans, to make with the money in order to get the best return for those whose money has been entrusted to the institution. So unbeknownst to many people, skyscrapers are often bought, or loans for skyscrapers made, by life insurance companies or teacher’s pensions funds looking to earn return for their investors.

His fantastic website, Adventures in Commercial Real Estate, has lots more details about the tools and techniques he uses to make these deals. Hope you’ll check out the site after you listen to our chat!