Asset-based financing provides quicker access to securing loans.

Asset-based financing provides quicker access to securing loans.

Traditional financing is suitable for a multitude of commercial real estate transactions, which often allow several months of lead time to secure funds. But what happens when funding for a property transaction is required immediately or when borrowers are inexperienced? While borrowers have a few options for quickly securing funds, asset-based financing can help them avoid the complexities involved with traditional financing methods and ensure that transactions close on time.

Due to their strict guidelines, many lenders are limited in the types of large commercial real estate projects they can finance. Loan agreements generally involve formal appraisals, third-party reports, and in some cases, approval from loan committees. In addition, many times borrowers must demonstrate previous experience or secure equity partners to qualify for loans. As a result, the approval process can be long, complicated, and uncertain. Commercial loans also can involve last-minute surprises if the bank or financial institution changes its terms — even with adequate assets, projects may not garner approval. Worse yet, some lenders can call their notes due at any time because their lending guidelines have changed or their investors or regulators are not satisfied with the lending institution’s investment choices.

Terms and Requirements

In situations that involve commercial real estate or other tangible projects, asset-based financing can provide a fast, direct path to loan approval. Asset-based funding leverages a borrower’s existing assets, eliminating appraisals, third-party reports, and loan committee approvals in most cases. Further, this option provides more privacy for borrowers and doesn’t require a minimum level of business experience or equity partners. Also, loans can be approved in as few as three to five days, with funding expedited in 30 days to 60 days.

Many developers use asset-based financing to avoid the hassles involved with proving their projects to traditional lenders. Because asset-based financing is leveraged against existing collateral, the collateral is all the support and leverage necessary to close the deal.To start the process, borrowers must request a letter of credit from an investment-rated bank. LOCs are bank-issued financial instruments that guarantee payments for a specified duration if the instrument’s conditions are met. Sometimes referred to as standby letters of credit or irrevocable letters of credit, LOCs must be unconditional. Borrowers also must have adequate support assets. Investment-rated banks issue LOCs directly to borrowers, with rating requirements based on the type and amount of financing requested.

Flexibility is another advantage of asset-based financing. With terms based on the amount and type of financing, borrowers might benefit from monthly compounded interest, payments to simple interest terms with deferred payments, and no prepayment penalties. Flexibility increases for LOCs greater than $100 million. Further, financial instruments are adaptable to meet borrowers’ needs. Many LOCs include an evergreen clause, which means the LOCs are renewable, allowing large projects to be drawn out over time if necessary due to internal or external factors.

The greatest benefit to borrowers is an increased loan-to-value ratio, which can be significantly higher than LTVs for traditional commercial financing, escalating to as much as 100 percent of a borrower’s LOC face value. These higher LTVs reduce borrowers’ upfront cash requirements significantly.

Borrower Characteristics

Asset-based financing is perfectly suited for large business entities, developers, and private-equity funds principally in the real estate industry and those primarily focused on tangible assets. Asset-based financing also provides a convenient funding environment for offshore development projects. With the added privacy these loans provide, developers can finance a diverse array of global projects that otherwise may not be attainable.

The ability to consolidate assets with other borrowers to gain leverage for large projects is another benefit of asset-based financing. For example, Great Midwest develops midsize apartments and condominiums, Lakes Development builds small to midsize houses, and T & M Development constructs town homes and mixed-use properties. All three developers had experience with projects in the $20 million to $45 million range and wanted to work on much larger projects. However, each company ran into the same challenges: not having enough assets or experience and not wanting to deal with equity partners taking a large portion of the profits.

The three developers combined their assets to form an entity called Tri-Universal. The group obtained an LOC for $120 million with a two-year term and an option to renew. It chose a fixed rate, as it was not comfortable with a variable payment method. In addition, the fixed-rate financing was more flexible in terms of payment options: Tri-Universal could pay once every year with simple, not compounded, interest.

As a result, Tri-Universal was able to complete a 300-unit condo project in Florida costing approximately $110 million. The company didn’t have to worry about a traditional lender’s criteria regarding previous experience on large commercial projects and wasn’t required to find equity partners. It also didn’t have to worry about the loan being called due when the project took longer than expected to complete.

In another example, Paradisio Development, a major resort developer, wanted to build resorts in the Caribbean, but faced several hurdles. The company had attempted to work with several lending sources and was frustrated by the process, which included 90 days to 120 days to get expensive third-party reports with no guarantee the project would be funded. Over time Paradisio went through the process with several lenders and spent $250,000 on third-party reports — without obtaining funding approval.

In summer 2006, Paradisio initiated the process with a lender who specialized in asset-based lending. As an established company with large assets and development experience, Paradisio was able to get a financial instrument valued at $500 million. This was especially helpful, since it had planned multiple projects in various locations. Since most projects Paradisio worked on took one to three years to complete, it obtained a one-year LOC with a renewal option. Paradisio also chose a fixed rate over a variable rate — even though the fees were higher — to save money on the interest over a longer time period. Ultimately the project was funded in 30 days.

Paradisio benefited from this financing by being able to work on multiple projects without worrying about the usual commercial lending process or the loan being called due. When the project took longer than expected, the company was able to renew its LOC. Lastly, Paradisio’s privacy was assured, allowing them to maintain a competitive advantage in the marketplace.

When traditional financing sources don’t suit a commercial real estate borrower’s needs, asset-based financing can be a viable alternative. This financing structure allows many commercial real estate borrowers to fund projects quickly, with privacy, and without the cumbersome restrictions of traditional financing methods.

Please note this is an article that we wrote for CCIM magazine back in July/August of 2008, here is a link to their website 

http://www.ciremagazine.com/article.php?article_id=1245

James Essa and Karna Hoskote

James Essa is president of Andorra Capital in Chicago. Contact him at (312)546 9733 or jessa@andorracapitalinc.com.

Karna Hoskote is president of MBGM Capital in Chicago. Contact him at (312) 628-7366 or khoskote@commercialfinances.net.

Copyright© 2010 CCIM Institute. All rights reserved.