In even the best market, owning commercial real estate can be challenging. Financial pitfalls can arise unexpectedly, threatening projects and pushing properties to the brink of insolvency. The current economic conditions are testing the mettle of even the most experienced owners and developers. An astonishing $8 billion in commercial mortgage-backed securities loans tied to multifamily properties are expected to mature by November, and over the next 24 months, $9 billion worth of loans are coming due in the Tri-State area alone (New York, New Jersey, Connecticut). With capital markets in disarray and distress permeating all sectors of the real estate industry, a growing number of real estate owners and developers are seeking creative debt solutions. It is in these moments of distress that rescue capital steps in, offering a capital infusion that paves a path toward stability, recovery, and profitability.
Despite the demand for rescue capital, many questions remain about the lending practice. Rescue capital is the term used to describe loans to developers and property owners facing economic hardship. Specifically tailored to situations where traditional funding channels have become inaccessible due to heightened risk factors, rescue capital serves as a strategic solution to prevent foreclosure or project failure. This type of capital infusion can be delivered through either debt or equity financing from specialized lenders, private financiers, equity sources, or financial institutions that offer this unique form of financing.
Here is an example of a situation that calls for rescue capital: a real estate developer who initially planned to build a condominium tower offering for-sale units is now, thanks to a softening market, converting those units into rentals. This shift creates financial complexities, as the original construction lender had planned on being repaid as units were sold. As circumstances have shifted, refinancing is now necessary. Given the current cautious approach of traditional lenders, the available choice may involve what is now commonly termed as a “cash-in” refinancing, requiring the developer to contribute extra capital. That’s where rescue capital comes in. Done right, it provides the funding to get the building across the finish line.
The criteria for qualifying for rescue capital vary among lenders and capital sources but generally include assessments of the borrower’s creditworthiness, the project’s potential for recovery, and the value and marketability of the property or asset. Lenders may also evaluate the borrower’s experience in the industry and their track record in completing similar projects. When under consideration for a rescue capital deal, lenders will typically conduct a comprehensive distress evaluation of both the project and the borrower, assessing factors like the project’s location, remaining construction complexity, and the likelihood of success post-capital infusion.
Rescue capital is also offered in various forms, each with distinct terms, conditions, and risk levels. Bridge loans, mezzanine financing, preferred equity, and joint venture partnerships are among the diverse avenues available. Bridge loans provide short-term relief while permanent funding is secured, whereas mezzanine financing and preferred equity involve longer-term arrangements with potentially higher returns for lenders. Joint venture partnerships often encompass shared ownership and profits between the borrower and lender. The terms and conditions of a rescue capital deal are tailored to the specific agreement between the lender and the borrower. These encompass the loan amount, interest rate, repayment schedule, maturity date, prepayment penalties (if applicable), and the rights and responsibilities of both parties. While specific terms will vary on every deal, a typical mid-market transaction for multifamily properties with up to 200 units may encompass an investment between $5 million to $30 million.
In rescue capital transactions, the lender’s degree of involvement varies based on the financing type. With bridge loans or mezzanine financing, the lender typically has a more passive role and does not acquire ownership or control of the project. The cash-in refinance scenario given above is a good example where a mezzanine loan or preferred equity structure would be the more efficient option. With respect to joint venture partnerships and preferred equity deals, lenders may play a more active role and can gain some degree of decision-making authority in order to protect their equity investment. This financing option would be appropriate in a situation where a building stalled mid-construction, requiring not only a capital infusion but also industry expertise to restructure the capital stack, stabilize the asset, and complete construction.
Rescue capital, like any form of financing, carries inherent risks. Lenders face the potential for borrower default and declining property values, while borrowers could contend with heightened debt and a loss of control. Nonetheless, the benefits are considerable for both parties. Lenders can enjoy superior equity returns compared to traditional lending, the prospect of shared profits in joint ventures, and the opportunity to support distressed projects that might undergo successful turnarounds. Borrowers can avoid bankruptcy, safeguard their assets, and sustain operations on projects that might otherwise stall. It is important to understand the specific regulations and legal requirements, depending on the jurisdiction, for receiving these types of loans. For example, a rescue capital provider located in New York City abides by the relevant laws and regulations related to real estate finance, lending practices, and securities in the state of New York.
Rescue capital deals typically involve a clear plan for borrowers to stabilize projects, enhance their value, and secure permanent financing to repay the rescue capital lender. In some cases, selling the property or seeking additional investment may be chosen as the exit route. Selling the property once it becomes stabilized is the most common exit strategy for a rescue capital deal. Alternatively, assets that experienced unexpected challenges during development – such as construction lasting longer than originally anticipated – may still need to infuse additional capital and, therefore, opt to seek another loan as an exit strategy. Although possible, this is a rare situation because once rescue capital has been restructured, there should no longer be a need for any additional funds. A typical rescue capital investment in mid-market multifamily projects can be structured with three- to five-year lifespans, depending on the project, though deals structured for properties that require extensive construction can go as long as six years.
While alternative capital sources exist – traditional bank loans, private equity, crowdfunding, seller financing, and angel investors or venture capitalists – when real estate developers and property owners are in distress, rescue capital is, in many cases, the only financing option. Rescue capital deals offer the unique opportunity to reposition a real asset and unlock a building’s value in a market where traditional forms of lending cannot bear to take on the risk or underwrite the remaining construction. As we continue to face unstable capital markets, rescue capital allows projects to overcome immediate financial hurdles and surge toward completion. By understanding its nuances, developers and property owners can navigate financial roadblocks, ensuring that their visions and assets succeed despite challenging circumstances.