31 Jul “What Capital Position Is Right For You?” Part I
BROOKE CIANFICHI, CHIEF OPERATING OFFICER
PART 1 – AN ILLUSTRATIVE CASE STUDY IN CAPITAL STACK POSITION
Your position in the capital stack does matter.
Like any investment, when considering an EB-5 opportunity, how you invest your money (capital position) is equally as important as where you invest your money (project-level risk). As an investor, you must consider:
- The feasibility and merits of each of the projects that you evaluate, and
- The level within the capital stack where you will be making your investment.
This three-part blog post focuses on capital stack considerations for an investor.
Let’s start with a case study.
AN ILLUSTRATIVE CASE STUDY ON THE COMPLEXITY OF CHOOSING YOUR CAPITAL POSITION:
Investors who research both project specific attributes and the position within the capital stack come to realize that there is no one “best” position in the capital stack. There are reasons to be in the “Loan-Type” position and there are reasons to be in the Preferred Equity position.
Part 2 of this post will define the positions, but first we will set the stage.
Pretend that you have two long-time friends, Sam and May.
Sam is a hotel operator in a certain city. He has operated small hotels with recognizable brands over the past 5 years in and around his city that, on average, generate $1 million each in operating income. Sam approaches you about an opportunity to build a hotel that he believes will generate $10 million in operating income. However, he would like to avoid licensing a national brand, as he believes his reputation supports an independent hotel and he can save on the costs associated with the “flag.” Sam asks you to be in the first mortgage position and cites its safety given your collateral position.
May on the other hand has a 50-year history across a larger geographical area. May operates hotels both flagged and un-flagged, with operating incomes that range from $10 million to $20 million per hotel. She has strong business relationships with major banks. May approaches you about the same opportunity as Sam and states that she is looking to include Preferred Equity because her first mortgage lender has already committed to the construction loan, and the Preferred Equity decreases her overall cost of capital.
Do you give Sam a first mortgage?
Do you give May equity?
Do you automatically feel safer with Sam’s mortgage due to your collateral position, or are the history and experience of the developer, and the ease of the developer accessing various capital sources equally as important in determining where in the capital stack you will opt to enter?
Once you have considered this small case, it is clear that there are many more factors to consider when investing than just the implied collateral position.
It is not enough to say that a debt position is automatically the safest position, because that only considers one of the 5 C’s of credit: the collateral.
Part 2 will detail the “Loan Model” versus “Equity Model” commonly seen in EB-5 investments.
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