Business Financing - Continued...

The business financing discussion continues from the front page...

The average investor is not aware of the opportunities the commercial real estate development finance industry routinely creates.  Yes, it is true that most of these "sweetheart deals" go to the large institutional investment companies that dominate Wall Street, but not as much as it was.  The advent of the Internet has served to shorten the lines of communication between developer/sponsor and the investing-public and Rainmaker has designed a higher-yielding syndication program that allows the opportunities to flow.

But what about those claims regarding the returns?  They seem a bit high and unrealistic...

The average investor does not understand the concept of financial investment leverage.  To put it plainly, financial investment leverage is the power to attract more capital to a given investment.  If you get a loan that equals 75% of your total budget, then the remaining 25% investment can be said to leverage $2.00:$1.00 (not exactly earth-shattering leverage).

But we are seeking more leverage because the developer is no longer really a developer.  No, in point of fact all commercial real estate developers are promoters of new investment opportunities for the investing-public.  They don't want their total opportunity diluted to the point where it isn't worth the effort for them to be successful and they drop the project; far from it.  The developer seeks to leverage the developer's seed capital and have the investing-public provide the rest of the financing in exchange for the lion's share of the gain resulting from the development, construction and stabilization of a given commercial real estate project.  

Here's where it gets good, so pay attention...

Every successful commercial real estate development project creates an incremental equity gain in excess of its cost of development.  This gain is based upon a sober assessment of the future cash flows the project is expected to generate.  The gain is the difference between the present value of those future cash flows and the cost of development.  This is commonly referred to as the "as-built" value and that is incorrect.  It is the income-producing potential of the property that creates the new value and this value is usually in the range of 12% to 20%.  That doesn't sound like much, but you haven't considered the leverage.  

If the project cost $10.00 to develop and has an equity gain of 20%, then it is now worth $12.00.  The project was financed with $2.50 in equity contributions.  Those investors receive 90% of that 20% - or 18%; a sum of $1.80 plus their original $2.50 when the developer refinances the project so the investors receive a total of $4.30.  If they had to hold their investment only one (1) year, then the actual cash-on-cash return worked out to be 172%!  If it was held for two (2) years then the cash-on-cash return per annum for the investment would be 86% per annum!  If the holding period was three (3) years (the maximum allowed for a construction syndication) then the average cash-on-cash return for the holding period would have been 57.33% per annum!