Question Category #: Credit Analysis
How do Senior Loans and Mezzanine differ, and why do many deals use both?
Senior Loans are secured Debt where the property acts as collateral, they tend to have the lowest interest rates , and they often have amortization periods that far exceed their maturities .
Senior Loans fund property acquisitions up to a certain LTV that lenders will accept, such as 60% or 70%. If the sponsor wants to go beyond that, it will have to use Mezzanine, which is unsecured Debt that is junior to Senior Loans.
Mezzanine has higher, fixed interest rates, either paid in cash or accrued to the loan principal, amortization is rare, and the maturity is almost always shorter than the maturity of Senior Loans.
How can you determine the appropriate Loan-to-Value or Loan-to-Cost ratio for a deal?
You look at the LTV or LTC for similar, recent deals in the market and use something in that range.
You could also size the Debt based on the credit stats the lender is seeking, such as a minimum Debt Service Coverage Ratio of 1.2x and a minimum Interest Coverage Ratio of 2.0x.
Suppose that the Debt Service Coverage Ratio is 1.1x, the Debt Yield is 8%, and the Going-In Cap Rate is 7%. What does this tell you about the deal?
The deal uses too much leverage because the DSCR is quite low lenders usually want to see at least 1.2x to 1.4x so theres enough cushion if something goes wrong.
Also, the Debt Yield and Cap Rate are very close, which means additional risk.
Top Real Estate Private Equity Firms
The top real estate private equity firms vary from year to year you should look at the PERE rankings for an updated view.
However, Blackstone, Starwood, and Brookfield are almost always in the top few positions.
Blackstone and Brookfield are gigantic firms that do much more than real estate, while Starwood is the biggest dedicated real estate investment firm.
Of the generalist private equity firms, Carlyle tends to have the second-biggest presence in real estate after Blackstone.
Investment Banking Industry Groups: Real Estate
Real Estate Investment Banking Definition: In real estate investment banking , professionals advise entire companies in the REIT, gaming, lodging, homebuilding, development, and real estate services segments on raising debt and equity and completing mergers, acquisitions, and asset sales.
You have to be careful with this definition because many firms, such as CBRE and Jones Lang LaSalle , also have real estate investment banking groups.
In most cases, however, these groups help raise debt and equity for individual properties, not entire companies so it is not actual investment banking.
Similarly, banks such as Goldman Sachs might have separate Real Estate Financing teams, but these groups raise capital for deals involving individual properties.
If the group advises entire companies on equity and debt issuances and M& A deals, it is REIB otherwise, its more like a brokerage role.
The main verticals within REIB are usually:
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Real Estate Investment Banking Interview Questions
Some REIB interview questions you should prepare are listed below.
Global Boutique Investment Banks
is a US-based investment and advisory firm with about 2,900 employees and $684 billion in assets under management as of June 30, 2021. It focuses on private equity, real estate, credit & insurance, and hedge fund investment solutions.
, established in 1945, is a global financial services firm with over 7,000 institutional clients worldwide. The company is one of the few remaining private partnerships left on Wall Street.
is an international investment bank and financial services firm with full year 2020 revenue of $1.6 billion and assets under management of $14 billion. The companys market capitalization was $1.0 billion as of September 10, 2021.
Centerview Partners, headquartered in New York, is an independent investment banking firm with additional offices in Los Angeles, San Francisco, Chicago, Palo Alto and London.
is a global boutique investment bank with 1,900 employees and over $4 trillion in announced M& A transactions.
Greenhill & Co is one of the leading investment banking firms with headquarters at Manhattan, New York City and locations in Dallas, Chicago, Houston, San Francisco, London, Toronto, Melbourne, Sydney, Frankfurt, Madrid, Tel Aviv, Tokyo, Sao Paulo, Singapore, Stockholm and Hong Kong.
, is a global investment bank with over 2,400 professionals and assets under management of about $300 billion as of December 31, 2020.
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Real Estate Operating Companies
Crow Holdings Old Parkland Hospital
Real Estate Operating Companies, or REOCs, like REITs, are companies that own and operate real estate. Rather than raising capital from private sources, publicly traded REOCs raise debt and equity in the public markets. Unlike investing in a REIT, investing in a REOC is like investing in any other company in which the cash flow is derived from several different activities. In the case of Real Estate Operating Companies, cash flow is derived from rent, buying and/or developing properties and then selling them, and managing properties for others. Similar to REITs, REOCs can also be private companies.
Brown Gibbons Lang & Co
Brown Gibbons Lang & Co. popularly known as BGL was founded in 1989 and is headquartered in Cleveland, United States. It is an independent middle-market bank providing financial service to its clients spread across the United States primarily in Chicago, Newport Beach, and San Antonio. It was formed with the aim of providing sound and unbiased advice from experienced and qualified advisors to business owners who were facing challenges in their industries. Businesses owners wanted experts who could analyze the opportunities and issues affecting their industries and businesses in particular, Brown Gibbons Lang & Co. took advantage of this opportunity and hence serves a very niche segment in the middle market business.
- Bank Services
Brown Gibbons Lang & Co. fulfill the corporate financial advisory and transactional needs of their clients. It primarily focusses on the real estate sector and provides investment banking advice on real estate, healthcare, industrial and multifamily space.
- Office Culture
Since Brown Gibbons Lang & Co. is an independent banker, it is generally believed that there are no cross-selling goals for its employees hence the advisory service will be unprejudiced and impartial.
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Real Estate Mutual Funds
Real estate mutual funds invest primarily in REITs and real estate operating companies. They provide the ability to gain diversified exposure to real estate with a relatively small amount of capital. Depending on their strategy and diversification goals, they provide investors with much broader asset selection than can be achieved through buying individual REITs.
Like REITs, these funds are pretty liquid. Another significant advantage to retail investors is the analytical and research information provided by the fund. This can include details on acquired assets and managements perspective on the viability and performance of specific real estate investments and as an asset class. More speculative investors can invest in a family of real estate mutual funds, tactically overweighting certain property types or regions to maximize return.
Real Estate Investment Banking Vs Real Estate Investment Trusts
People might get a little confused about Real Estate Investment Banking and Real Estate Investment Trusts because they contain Investment in their terms. Yet in finance, they are classified into different sides. While Real Estate Investment Banking is called the Sell-side, Real Estate Investment Trusts are on the Buy-side.
1.1.1 Business Model
REIB Investment Banking is a broad term that encompasses capital raising and strategic transaction advisory services for real estate companies. They do not invest in any properties. The operation of REIB is considered less complicated than REITs, where REIB solely offers advisory service and the beneficiary pays the consultancy fee in return.
1.1.2 REITs Capital and the Scheme of Payout
Most REITs trade on major stock exchanges, and they offer a number of benefits to investors. REITs mostly call for capital in the equity market, they rarely employ debt instruments to appeal for capital. REITs provide all investors the chance to own valuable real estate, the stockholders of a REIT earn a share of the income produced through real estate investment without having to buy, own or finance property.
Real Estate companies have to meet a number of requirements to qualify as REITs. REITs must pay out at least 90% of their taxable income to shareholders in the form of dividends in fact, a majority of these companies pay 100%. Shareholders pay the income taxes on those dividends.
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Question Category #: Waterfall Schedules
What is the waterfall returns schedule, and why is it widely used in real estate?
See our video tutorial on the real estate waterfall model.
The waterfall schedule allows the Equity Proceeds from a deal to be split up in a non-proportional way if the deal performs well enough.
For example, if the Developers contribute 20% of the Equity, normally they would receive 20% of the Equity Proceeds.
But a waterfall schedule lets them receive 20% up to a certain IRR and then 30% or 40% of the Equity Proceeds above that IRR if the deal performs well enough.
This structure incentivizes the Developers or Operators to perform while taking away little from the Investors or LPs.
How do Preferred and Catch-Up Returns work in waterfall models?
Preferred Returns give one group, such as the Investors or Limited Partners, 100% of the positive cash flows from the property until they reach a specific Equity IRR or Multiple, such as 10% or 1.0x.
Then, the other group may receive Catch-Up Returns that catch them up to that same Equity IRR or Multiple, which means that the other group will receive 100% of the next available positive cash flows up to that level.
Once these thresholds are reached, the Equity Proceeds will be split based on percentages.
Does Investment Banking Pay More Than Private Equity
Investment banking does not pay more than private equity in regards to starting roles. Private equity roles are typically for individuals who already have work experience, so the jobs are not necessarily entry-level. Many investment bankers graduate to working in private equity, therefore, private equity salaries tend to be higher.
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Real Estate Investment Banking Exit Opportunities
Since REIB is a limited field, professionals do worry about its exit opportunities.
What career opportunities are available if you decide to exit from real estate?
Usually, the most common transition from REIB is to Real Estate Private Equity but the transition is not always smooth.
Problems with skills might arise such as valuation issues but it mainly depends on the bank you are working with and your role.
You can also think of moving into long-only REIT Asset Management, real estate hedge funds, real estate operating company and other real estate companies.
Lastly, you can also transition to generalist Private Equity but it will be tough to integrate yourself with the workings of a PE fund.
However, if you demonstrate a lot of interest and knowledge, skills, and industry-relevant experience, getting into PE will not be difficult. Check out our series on PE.
- How to become a private equity analyst?
- How to get private equity job?
- Private equity interview questions
- Private equity vs. venture capital
Avoid moving into commercial real estate development because its more brick and mortar business and your IB skills wont be a beneficial match.
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Exit Opportunities For Healthcare Investment Banking
The exit opportunities can be Real Estate Investment Trust, Private Equity, Hedge Fund,Venture Capital,Corporate Development, Corporate Finance, and real estate companies.
Real Estate Investment Trusts:
REITs are the most common destination for investment bankers. REITs generate revenue across a range of property investments. Working in REIB allows you to gain exposure to various real estate investment deal types. The skill sets you gain in REIB is quite applicable to REITs, making you a strong candidate for REITs roles.
At the real estate group, you get exposure to a variety of transaction types such as M& A and CM, though CM is less frequent. If you have related-investment deal experience throughout the time you work here, you can be a strong candidate for Real Estate Private Equity, or other types of Private Equity.
Hedge Funds and Venture Capitals:
Hedge Funds and Venture Capitals are not popular exit opportunities since the real estate industry is quite established, and there are few start-ups in the space. Still, working in an investment bank will be a solid stepping stone to land a job in both Hedge Fund and Venture Capital if you want to apply for these funds.
Corporate Development and Corporate Finance:
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Investment Banking Vs Private Equity
Theres no doubt that there are connections between investment banking and private equity, but these services are not the same thing. Investment banking exists in an advisory role, with the primary goal of raising capital. Private equity, on the other hand, is an investment business.
Private equity firms use pools of capital to invest in businesses and make money from charging a percentage on the pools while generating significant returns on their investments. Investment banks instead advise their clients on large transactions while raising capital for their clients.
Real Estate Private Equity Vs Reits Vs Real Estate Operating Companies
Real estate investment trusts raise debt and equity continuously in the public markets and then acquire, develop, operate, and sell properties.
REITs must comply with strict requirements about the percentage of real estate-related assets they own, the percentage of net income they distribute in the form of dividends, and the percentage of their revenue that comes from real estate sources.
In exchange for that, they receive favorable tax treatment, such as no corporate income taxes in many countries.
Real estate operating companies are similar, but they do not face the same restrictions and requirements and do not receive the same tax benefits.
Real estate private equity firms differ in the following ways:
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Real Estate Investment Banking Jobs
There is a lot of scope in the real estate IB industry. In this section, we will look into real estate IB jobs and career path.
The real estate IB industry is a niche zone. Jobs are available but one has to be really on the lookout for the best of opportunities.
You can search for jobs on job search engines like Monster.com but before initiating a search understand how you want to be placed in the industry.
The real estate IB has segments, as explained below.
Real Estate Investment Trusts
REITs are equity firms involved in the improvement, operational, buying and selling of properties.
REITs can function globally or segment their business according to the nature of buildings , property types and location.
Some of the REITs are listed publicly while others function as associations and corporations.
Working in REITs will involve activities related to capital raising and cash flow maintenance.
Most of the incomes are paid as dividends and there is always a need for constant cash flow.
IB in the Residential Sector
Sometimes, companies involved in the residential sector such as home building companies remain limited within a specific geographic region, and such companies have internal financing divisions which often hire real estate analysts and associates to understand the market better and look into real estate financing.
Commercial & Large Individual Properties
Returns on these buildings are highly seasonal and are based on amenity investments.
What Are Middle Market Investment Banks
Middle market investment banks are financial institutions or intermediaries that deal mostly with mid-market firms, specifically for raising debt or equity capital, as well as mergers and acquisitions. Middle market firms are mid-size businesses having annual revenues from $10 million up to $500 million and 100 to 2,000 employees. Some of the most well-known middle-market investment banks are Robert W. Baird, Piper Jaffray & Co, Needham & Co, and Stifel Financial Corp.
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