From Debt to Equity: Navigating the Spectrum of 'Dequity' in CRE Finance
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Episode Transcript:
Today we're exploring an intriguing term that's been making waves in the commercial real estate world: "dequity."
This term took center stage at a recent Bisnow event, sparking conversations among many in the CRE community, all pondering a fundamental question: How do I finance my project in these times?
Bisnow, a key channel for communication within the commercial real estate industry in the U.S. and UK, keeps a close eye on the industry's evolving terminology. So naturally, we've taken it upon ourselves to delve into the world of "dequity" and decipher its significance in the realm of CRE.
So, what exactly is "dequity"?
Well, "dequity" is essentially a blend of "debt" and "equity" – two distinct financial terms. At first glance, this term might appear perplexing, but let's break it down to its core.
In the realm of commercial real estate finance, "dequity" represents a spectrum of investment structures that exhibit traits of both debt and equity, positioning itself neatly between these two financial concepts. Borrowers typically don't approach lenders seeking "dequity" directly; instead, they seek a solution to bridge the gap between their borrowing capacity and the equity they can contribute. This gap can be substantial and can be filled using various mechanisms, such as preferred equity, mezzanine debt, A/B loans, or subordinated debt.
Now, are these financing structures something entirely new?
Not really. What seems to be new is the industry's packaging of these structures under the term "dequity." Think of it as an assortment of alternative financing options that sit comfortably between the realms of debt and equity. Some of these structures lean closer to debt, while others align more with equity. It's when you amalgamate these structures within a single deal that you can accurately categorize it as "dequity" because it now encompasses elements of both.
Moreover, these financing structures themselves can exhibit features of both debt and equity. For instance, preferred equity takes precedence over common equity, a characteristic commonly associated with debt. On the flip side, convertible debt has a strike price that, when triggered, can transform it into an equity position. It's essentially a hybrid financial term.
But here's an interesting twist – "dequity" isn't exactly a novel term.
Georgette Chapman Phillips, the dean of the College of Business at Lehigh University, published a comprehensive paper on "dequity" back in 2005. While she doesn't claim to have coined the term, she was an early proponent.
Back in the day, the concept of "dequity" was relatively fresh, especially in the context of capital markets during the 1990s, particularly in the world of CRE. During that era, lenders became increasingly cautious about financing the traditional 90% of a deal, which was the norm at the time. As we entered the new millennium and witnessed the ascent of CMBS and various other lending forms, this financing ratio dropped to 65%. So, even though "dequity" has been around for almost two decades, it's experiencing a resurgence.
But why is it gaining traction now?
Well, the world of capital markets is currently navigating uncharted waters. The deals happening today demand more creative structures than ever before.
During the prolonged period of low interest rates when financing flowed freely and CRE markets stood strong, the distinction between financing products leaning towards "equity" or "debt" wasn't a major concern. However, those times are behind us. In today's landscape, the CRE industry is paying much closer attention to the intricacies of deal structures, dissecting them meticulously. It's a phenomenon where new terms emerge when the market seeks clarity.
This is Tyler Cauble, Signing off