- By Abhishek Bommasamudram
In the Real Estate Capital Markets, the Assets/Properties are Valued, Financed, and Transacted. These markets help developers and Investors access the capital, which they use to fund newer projects, purchase already existing properties, and other investment ventures. More than that, the capital market helps to connect, supply and demand and allocate the investments. We know that capital markets are the financial markets where long-term financial instruments like stocks, bonds, and other securities are traded, these investments help the companies/entities with their new projects and restructuring meanwhile investors by taking securities hope for their returns in the future.
In the same way, the real estate capital market has its unique market where they cater to the needs of the infra developers. This comes under the Private capital market. Here it includes private equity and private debt securities. There are REITs as well which come under public [REIT: Real Estate Investment Trusts]
PUBLIC: REITs are traded openly in public; this is an excellent way to invest for investors to get exposure in real estate but at the same time not invest a lumpsum amount on a single project. These are efficient, fast-moving, and highly liquid and have higher exposure to beta.
PRIVATE: Here, high-net-worth Individuals and Institutional Investors usually deal with Private debt and Private Securities, these funds are pooled, and the capital formed is used to fund and finance real estate projects. These are inefficient, slow-moving, Illiquid, and have more exposure to Alpha.
CAPITAL STACK
A full Set of Financial Instruments used in commercial real estate property, including various forms of debt and equity. It’s also called Capstick. Capital stack is the set of financial instruments used to fund a single real estate venture. For example In a House, we can easily bifurcate equity from the mortgage, but when it comes to commercial real estate Finances can be much more complex, involving more no. of parties with different capital structures and different financial instruments.
1.Senior Debt: Senior debtor is secured by the mortgage on the property itself if the borrower (Developer) fails to pay and defaults on the loan, the lender is entitled to take ownership of the property because of this it greatly reduces the risk on the principal invested because at worst lender owns the property and will look to maximize value by selling the property or even selling the non-performing loans. The rate of return is flat, and they are given the 1st payment priority in the capital stack. They usually give importance to the borrower’s ability to repay the loan.
2.Mezzanine Debt: Once the developer pays the operational expenses and senior debt the remaining income must be paid to the Mezzanine Debtors (2nd payment priority) With a fixed. In the worst-case scenario developer defaults on the given loan both senior and mezzanine debtors come to an agreement called the Intercreditor Agreement where they spell out their rights and interests. Mezzanine Debtors have a higher rate of return as the risk is also higher compared to Senior debtors.
3.Preferred Equity: Preferred Equity is the hardest of all the Capital Stacks because they are very flexible. (3rd payment priority) over Common Equity. There are 2 types of preferred equity: i) Hard Pref Equity and ii) Soft Pref Equity. In hard P.E. they get their fixed Coupon returns like Mezzanine Debts they also have the right to remove the developer if they fail to pay. On the other hand, Soft P.E includes some of the financial upsides If the project performs well and they have more limited rights. Hybrid Risk/Return Profile is less risky compared to common equity.
4.Common Equity: The riskiest and most Profitable in the entire stack is common equity, they have no cap on their potential returns. According to industry standards, I’ve come to know that all the investors earn a preferred return until a certain Annual Return like 8% after that the developer would take a disproportionate share of up to 40% of profits and the remaining 60% of it is shared among others on pro-rata basis.
Many Real Estate Consultant Companies provide Services to their Investors and act like a Bridge to the Developers, the Big 4 in Real Estate Consultancy are CBRE, JLL, Colliers andCushman Wakefield.
Services such as:
1. Investment Properties: Here the Global Capital Market Experts solve Investor’s (Client) complex challenges by combining world-class research to deliver maximum returns on their investment. Here the investors can personalize their investment opportunity in real time and simplify their due diligence process.
2. Debt and Structured Finance: Here, the investors get to choose their most competitive and most reliable debt executions, complete understanding of capital stacks helps in yield maximum returns.
3. Investment Banking: Here the core services are dissected into 3
Merger and Acquisition: Both Buyside and Sell side Advisory will be given to investors with corporate valuation and Discounted cash flows. Advise investors on OPCO (Operating company) and PropCO own operated business assets and Prop Co helps to manage OPCO's Debt.
Equity Placement: Capital raising and Recapitalization of Joint Ventures and creations
Fund Placement: Capital Raised across various ranges of profiles and geographics and Sectors.
Impact of Capital Markets on Real Estate
The capital market plays a significant role in real estate. Interest rates, set by the central bank, influence demand for properties. Rising employment can boost the development of commercial and residential projects. However, inflation can inflate property values, requiring adjustments to interest rates. Additionally, government policies can impact taxes and spending directed towards real estate.
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