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are two types of debt structures that can be on a portfolio, and each property within the portfolio has its own loan or every property is connected under one loan otherwise known as a “cross collateralized loan.”
A cross collateralized loan is considered riskier because it can potentially put a lot of restrictions on cash flow for investors and substantially limiting the sponsors ability to sell the portfolio on behalf of investors. The DSTs might have multiple properties providing diversification for investors, but if all the properties are under one loan this does not necessarily provide the diversification that most investors think they are getting. For example, there could be clauses within the loan that can significantly affect an investment such as when a certain amount of properties stop paying rent or go bankrupt the lender can call the loan or do a cash flow sweep (meaning that because of one portion of the portfolio is having problems now the entire investment is at risk).
Credit rating clauses that allow a lender to sweep cash flow for a period of time should a certain tenant or a percentage of tenants’ credit ratings drop. For example, you could have a portfolio of triple net lease corporate backed properties that do not go out of business and do not stop paying rent but maybe there is a recession or something
going on at the corporate level of your tenant that temporally drops their credit rating and this gives the ability for the lender to lock all the current cash flow in the lenders lock box. As a result, now investors do not have a current cash flow.
We also have seen sponsors place a few properties within the portfolio that are not officially investment grade tenants per Moody’s Standard and Poor’s ratings and this is misleading to investors as a non-investment grade tenant can have a significant default risk. Lastly, when you have a portfolio of properties under one loan it can potentially limit the ability to sell the portfolio as in most cases you will need to sell all the properties at the same time. What if a buyer only wants to buy a portion of the properties because they do not like 3 of the 20 properties? The sponsor may be forced to reduce the price to make it more attractive to that buyer. If the portfolio is debt free or not cross collateralized it can provide more potential exit strategies for the sponsor.
In short, investors that have the ability to stay debt free potentially mitigate risks that a loan can bring on property and its exit strategies. If investors need to take on debt or are comfortable with the risks of debt it is important to understand the pros and cons of the different debt structures available.
This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation. There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.
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APARTMENT MANAGEMENT MAGAZINE - JUNE 2021 CS-17