Equity Capital For The Retail Sector
The who, what, when and why of today's capital rich market.
David St. Pierre

David St. Pierre

Unlike other income producing commercial property types, like such as for-rent multifamily, where virtually every project requires a significant amount of equity capital, not every retail project necessitates the search for and securing of equity financing in order to complete the deal and put a shovel in the ground. As a result, opportunities for third-party equity providers and developers to come together abound in the multifamily and other sectors, but not so in the retail environment.

This is not to say, however, that equity capital funding is not at all suited to the retail world. On the contrary, there are several instances in which an equity partner may be needed in order to get a retail development and/or redevelopment project “off the ground.”

Who Needs It?

The contrast between retail projects and other income producing commercial property types is dramatic in their need for equity capital. By way of example, a developer of a multifamily project, regardless of the strength of the development team, the merits of the proposed project or the project's prospective economics, will find it difficult to obtain a construction loan for more than 80 to 85 percent of the total project cost. This is due to the fact that 100 percent of the units in a multifamily project are speculative — there is no pre-leasing. As a result, on every multifamily project there is a need for at least 15 percent equity and, in many cases, even more. As a result, an equity capital provider can step in at the time construction is ready to commence and be a value-added component to the project.

Contrast this with the retail segment, where the nature of the business is for developers to significantly pre-lease their centers before a construction lender will place debt on the project. When it comes to ground-up development, most lenders like to see projects that are at least 50 percent pre-leased. Clearly, it is much easier to calculate the value of a project when the economics are locked in place and the income stream is known. As a result, construction lenders feel comfortable lending against a project's prospective value and regularly provide 90 to 95 percent of the construction cost, which makes the equity requirement far smaller and the need for and value of third-party equity far less significant.

So, since construction lenders are willing to finance nearly the entire cost of the project once a project is significantly pre-leased, it would appear as though there may never be an instance where a retail developer would need to bring in an outside equity partner and give up a piece of the deal. However, there are several situations when a retail developer may find that bringing in a third-party equity partner makes sense.

• Land Acquisition

The period of land acquisition, well before the center is pre-leased, is an obvious situation in which an equity partner can add tremendous value. Having an equity partner to take down the land may be the difference between having a deal to develop and losing the opportunity all together. On the flip side, this is a risky scenario, and finding an equity partner willing to take that kind of risk is not an easy task. The business strategy, potential interest from tenants, and the strength of the location need to be very compelling in order to attract an equity partner this early in the development process.

Clearly, being able to bring in an equity partner early in the process to assist in the acquisition of the land and possibly to participate in pre-development costs makes sense, but there are other scenarios when it may make sense for a developer to bring in a third-party equity partner later in the development process.

• Large Developments

For larger projects, such as a $150 million lifestyle center, coming up with the 5 to 10 percent requisite cash to meet a construction lender's equity requirement can strain even the most sophisticated and successful developers. Not every developer has ready access to $7.5 million to $15 million of equity capital.

• Active Pipelines

Even smaller projects of $20 million to $30 million can create the need for a developer to bring in an equity partner. For example, developers who are supporting a very active development pipeline might find themselves strapped for cash with three or four projects each requiring a couple of million dollars of equity. In aggregate, these “5 to 10 percents” add up, and these developers may need to find alternative sources of capital.

• Acquisition and Redevelopment

Because the future value and the timing to create value in a redevelopment scenario is often more speculative, interim lenders are typically unable to maximize their loan amounts the way they are on pre-leased ground-up development projects. As a result, developers are faced with greater equity requirements and the potential need for an outside equity partner.

What Next?

If there is a need or a desire to bring in an outside capital source, a developer needs to determine its goals and objectives with regard to the project. There are numerous approaches and investment styles represented in the world of equity capital providers, and which equity partner a developer brings in will have a dramatic impact on its ability to achieve its goals.

The vast majority of the equity capital in the market is available from large “institutional” partners whose typical investments are structured based on a short term, 3- to 5-year investment strategy. This philosophy is a good fit for some developers, but there are many who feel this is not the ideal structure under which to bring in a partner. Given the short term investment philosophy, the developer will have to submit to the whims of its investment partner, who is driven to maximize internal rates of return on the investment and will make certain demands regarding the direction and timeline of the project. Not surprisingly, a lot of developers feel like “order takers” when they partner with such an investment partner. They're told when to build, how much to spend and when to sell off their projects.

The opposite   approach is equity capital from   private equity funds, whose capital is typically from high-net-worth individuals or families. These funds, although they may not be as large as the institutional investors, are typically short on red tape and bureaucracy and long on investor patience. Such an equity partner can allow the developer to have more control over the project from the very beginning and can provide more flexibility. This type of equity source will likely have only a small investment committee that is free to make decisions and can usually commit to action more quickly than a typical institutional firm.

Because the source of capital is individual investors, not institutional investors, this type of equity capital often differs in its investment approach. Rather than the short term and quick return, private equity can invest in projects for the longer term, and can be more patient when it comes to the overall investment strategy. Developers who are interested in holding their assets for longer periods are particularly attracted to such an equity partner.

The Right Fit

Most equity capital providers interested in partnering with a developer are looking for an experienced development partner. In fact, project sponsorship is one of the most important elements that are evaluated. It's critical that the development partner boast strong industry relationships and a notable track record.

As a developer, if there is a need or a desire to bring in an outside equity source into a retail development, start the process early and choose your partner wisely. There is a significant amount of capital in the market and there is a wide variety of investment structures and strategies.

David St. Pierre is co-founder and president of Lyndhurst, Ohio-based Legacy Capital Partners, a $44 million private equity investment fund. He can be reached via e-mail at dsp@lcp1.com.