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Debt vs. Equity: Commercial Real Estate Capital Considerations

8/12/2016

commercial-real-estate-capitalIf you need capital for your commercial real estate project, you’re usually either getting it through debt or equity. How do you decide which option is best for your project? Rely on your commercial mortgage banker to guide you to the right choice for your situation.

The lure of not taking on debt can make equity financing very attractive. Repayment is not required if the business fails. Cash flows are more fluid because income is not earmarked for monthly loan payments. Sometimes the investor reputation brings market awareness and additional credibility. Below are other considerations:

Cost of capital

Debt: In addition to interest paid on the loan, lenders often have closing and third-party costs for attorneys, environmental studies, and more. These costs may not be obvious to the uninitiated. Count on your mortgage broker to outline all the costs associated with the lenders offer.

Equity: The cost of equity financing is different. Monthly repayments are not involved, there is no interest rate or closing costs to negotiate. However, an equity partner is a partner and shares ownership. Equity partner has every right to exert influence over day-to-day operations and financial decisions. The right to sole decision-making is forfeited in an equity arrangement.

Approval timeline

Debt: Underwriting a commercial real estate loan can be completed in a relatively short time frame, especially when working with a mortgage broker firm that helps prepare the financial package and knows the details of the lender’s process.

Equity: An equity investor may take much longer to come to a conclusion about investing in a project. Unlike a lender, the investor does not have the property as collateral so the personal income and financial background of the applicant becomes much more important to an potential equity partner.

Length of the arrangement

Debt: The loan terms include an end date when the debt is either paid-off or refinanced. The arrangement is for a finite period. A lender has no interest in property beyond the end of the loan period.

Equity: The relationship with an equity investor continues indefinitely. To terminate it, the owner(s) must buy back the investors percentage of the business, at a negotiated price and only if the investor is willing to sell. When considering equity as the source of capital be prepared for a long time partnership.

Remember that debt is not limited to banks as lenders. A commercial mortgage broker will have a network of many non-bank lenders. Because these lenders are not subject to the same regulatory requirements as banks, they often grant loans to projects banks are not equipped to fund.

Whatever your situation, ask your mortgage broker to explain the pluses and minuses of each. W Business Capital begins the process by understanding the client objectives first. Those objectives will determine the best capital solution for your project. Let’s discuss the project you have in mind. Call W Business Capital at 208-297-7794.