This is the year that I got time to reflect on some of the private projects that I have been involved over the past 5-year.
Canada’s RE sector had been advancing strongly until this year and it especially captivated the wealthy immigrants’ imaginations:
- True ownership (instead of 50 – 70 years of right of usage)
- Seemingly safe & tangible (everyone loves to see his / her investments in tangible form and has a bragging right)
My network fits the RE developers’ financing targets, therefore, I have seen quite a few private financing deals from mid to large developing groups, mostly aiming to raise junior securities on individual projects level from Accredited Investors.
You ask, where was the equity in this picture? Exactly, that’s a main goal of the scheme, developers get almost 100% of the equity without putting up much capital at risk. In addition, they would benefit from multiple streams of income while building the things up (probably recoup the land cost at a good multiple if they owned the land at 1st place)
Head, the development was a huge success & Loans, mezzanine and junior securities got paid off, the gravies belonged to the developers; Tail, the bank will be made whole via its 1st lien, Mezzanine guys would probably get the rest & take over the project being fulcrum positioning on the capital stack.
Here, I am not criticizing the developers, since most of these folks followed through on their promises to get the things built & pay the dividends or interests to the investors on time, partly thanks to their execution & partly thanks to the bull market. At the end of the day, we still need more housings in the society.
I am just deliberating on the particular schemes that were used to get the projects financing ready, from the standpoint of someone who’s evaluating the LP Units with fixed-income like structure.
In my humble view, there are a number of issues that make these commitments especially not attractive philosophically:
- Mismatching between Risk & Rewards: the junior securities (preferred shares / notes, etc.) holders were taking on equity like risks but only being compensated at fixed-income levels
- Minimum liquidities on the LP units
For non-Accredited Investors, you are not missing much of not seeing these type of deals.
Mr. Graham’s Security Analysis documented similar schemes in New York City real estate developments prior to 1929, history never repeats itself, but it does often rhyme.
Let me quote the followings from the master as a conclusion of today’s reflection:
- Safety is measured not by specific lien or other contractual rights, but by the ability of the issuer to meet all of its obligations. This ability should be measured under conditions of depression, rather than prosperity
- Deficient safety can not be compensated for by an abnormally high coupon rate
- Instead of asking “what security? what price?”, let us ask, “In what enterprise? On what terms is the commitment proposed?”
What has been will be again, what has been done will be done again, there is nothing new under sun.
