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The following analysis of capital providers is not all-inclusive. It is a high level analysis and exceptions may be found in certain circumstances. While there will always be debate among industry pundits, and there are certainly pros and cons that can be identified when evaluating any capital provider, we have chosen to profile the following genres of capital providers as they are most often accessed by the mass of borrowers in the market place:
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Banks
Pros: Banks are direct lenders and excellent sources for construction/mini-perm financing. They have excellent staffing levels and local market knowledge. Banks have the ability to be very fee competitive when they choose to do so.
Cons: Even though more and more banks are developing broader product lines (Agency, CMBS, and Mezz products), they are new to those product lines and are still primarily construction lenders. Most permanent loans originated by banks are still portfolio loans, which mean that they are short-term, floating rate, full recourse loans and are therefore rarely competitive. Certainty of execution can often be an issue due to post acquisition integration issues caused by bank merger mania or how often the relationship officer dealing with the borrower has no impact on credit decisions. Other then when dealing with very large banks, a borrower may run afoul of geographic, loan-to-one, or legal lending limit constraints.
Conclusion: Banks are most often your best source for construction financing, though rarely competitive for other forms of financing.
Mortgage Brokers
Pros: Mortgage brokers are often ex-lenders who have left an institutional environment for the entrepreneurial life. They typically have a solid knowledge of their local market and close relationships with local banks. They frequently engage smaller borrowers, smaller projects, or projects that fall outside traditional underwriting guidelines. Good mortgage brokers can be hard to find, but when you do find them, they can be an effective advocate.
Cons: Mortgage brokers are more often than not smaller, local organizations that do not lend their own funds and typically have no formal or contractual relationships with direct lenders. They rarely have warehouse or servicing capability and generally have few employees with little invested in infrastructure. While many mortgage brokers attempt to work out of market, they typically don’t have the staffing, market knowledge, or capital markets contacts to do so effectively. There is also regularly increased fee burden when working with mortgage brokers as they may be required by the lender to collect their fee from the borrower.
Conclusion: Make sure that you are dealing with a reputable and experienced mortgage broker. Most often mortgage brokers will be the best option for projects under $1MM in value, projects that have underwriting issues, or borrowers that have suitability issues.
Mortgage Bankers
Pros: Mortgage bankers are usually a step-up in the food chain from mortgage brokers. Mortgage bankers are generally very seasoned commercial mortgage professionals. They typically have more staffing and infrastructure than mortgage brokers. Mortgage bankers usually possess warehouse and servicing capabilities with geographically exclusive correspondent relationships with life insurance companies. Many mortgage banking firms also have agency, pension, and conduit access as well. Most often, mortgage bankers will provide par pricing to borrowers.
Cons: Most mortgage banking firms, while larger than most mortgage brokers, are still relatively small organizations. Although mortgage bankers typically possess correspondent relationships, they usually are not truly direct lenders. With rare exception, most mortgage banking firms are also locally or regionally focused. Most mortgage banking firms tend to possess more expertise in senior debt and have less expertise with fewer options for structured finance. Very few offer professional services.
Conclusion: Since the mortgage banker’s greatest value proposition is usually a correspondent relationship with a life insurance company, they will most often use that as their preferred solution and are most effective when seeking low to moderate leverage, non-recourse permanent financing. Note that other lenders such as financial intermediaries and Investment Banks, typically have life insurance relationships. Furthermore, many life insurance companies are moving toward open shops and away from correspondent lending. Mortgage bankers are a viable option for local borrowers with limited needs.
Financial Intermediaries
Pros: Intermediaries are essentially an evolved form of old-school mortgage bankers. While most financial intermediaries are not truly direct lenders, they typically possess extremely close capital markets relationships. Unlike most mortgage brokers and mortgage bankers, financial intermediaries often have a national footprint with offices in most major markets. In addition, they may possess warehouse, servicing, loan sale, and brokerage services. Financial intermediaries often have a better knowledge of structured finance than their banking, mortgage broker, and mortgage banker counterparts.
Cons: Most intermediaries are still not direct lenders and offer limited professional service offerings. They have typically grown by merger or acquisition and have many of the same post transaction integration issues as their banking counterparts. Furthermore, there is not tremendous consistency of subject matter expertise or core competencies between offices. The borrower’s fate will largely be placed in the hands of the local office they happen to be working with.
Conclusion: Intermediaries are a very capable and more sophisticated version of the mortgage banker. They are suitable options for borrowers needing more expertise or coverage than old-school mortgage bankers might offer.
Investment Banks
Pros: Investment Banks typically have an international footprint and offer the broadest access to capital by lending and investing their own funds as well as the funds of other investors and capital partners. Investment Banks generally offer the most competitive and sophisticated financing solutions. They have often grown on an organic basis, which means that they offer borrowers more continuity of process and culture than banks and financial intermediaries. Investment Banks have more experience in structured finance than the aforementioned capital providers. They offer a depth and breadth of subject matter expertise not offered by other capital providers in that they often have investment advisory arms, investment sales, and professional services groups. Each allow borrowers to leverage market research, financial engineering, acquisition & disposition services, construction management, project management, and a variety of other value added service offerings.
Cons: Investment Banks often have higher minimums and more rigorous sponsorship suitability requirements, making it more difficult for smaller borrowers or smaller projects to get through the door.
Conclusion: Investment Banks provide larger and more sophisticated borrowers with broader access to capital and offer more value-added services than the other capital providers mentioned above. There are rarely sound reasons for a borrower to limit their access to capital, subject matter expertise, or value-added services other than lack of access or exposure.
Engaging the Appropriate Capital Partner
Once a borrower has selected the appropriate capital provider, it is essential that the capital provider be engaged as early on and at as high a level as possible. Experienced sponsors realize the benefit of getting their capital provider involved early in the planning process. Waiting too long to involve your lender will typically lead to a project built with less leverage and at a higher cost of funds. By including your capital provider in the beginning of the project planning process, you will end up with a project plan that is built around optimizing capital formation, leading to greater project profitability.
While architectural and engineering input are critical to a project's success, designing a project to secure the attention of the capital markets is even more critical. If you happen to be working with a capital provider that provides financial engineering or other value-added professional services as part of their engagement, your project will likely experience greater velocity, a higher degree of continuity, increased economies of scale, and synergy between involved professionals with higher leverage and an overall reduction in cost of funds on the project.
Effectively utilizing the entire capital structure to maximize leverage, while achieving the lowest blended cost of funds and isolating risk, is essential to the creation of a solid capital formation strategy. In general, the farther you move up the leverage curve, utilizing more leverage in the senior position, the lower the overall cost of funds will be. Conversely, the deeper you move down the capital stack, utilizing mezzanine or equity instruments, the more expensive the cost of capital.
Selecting the appropriate capital provider and engaging them properly will aid in the streamlining of the borrowing process. If borrowers focus on capital formation as a priority at the early stages of project planning, then the likelihood of increasing profits in a risk managed environment is high.
AMERICAN CITY CAPITAL PARTNERS, LLC is a leading small to middle market Investment Banking firm, providing our commercial real estate corporate clients with loans, structured finance, investment sales, and advisory services.
AMERICAN CITY CAPITAL PARTNERS, LLC is headquartered in Washington D.C. with additional offices in major markets in the United States. More information about the company can be found by calling 888-840-0061 or by visiting the company website at www.americancityhomes.com
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