Suneet Singal on senior debt and mezzanine financing

Suneet Singal has a published background in real estate and corporate finance, which includes the vocabulary of a capital stack even when no stack is being offered. Filings on this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. A filing about an officer is not a loan agreement. Senior debt is usually the first mortgage. Mezzanine financing is usually a subordinate loan, often secured by equity in the owner rather than by a second deed on the land. Preferred equity can look similar in a spreadsheet and still be a different contract. This entry uses a labeled hypothetical stack, lists the terms the documents must state, and says what the stack cannot promise.

Who gets paid first

Think of the capital stack as a line for cash and a line for loss. Operating cash usually pays operating expenses first, then senior debt service, then any subordinate debt the documents allow, then equity, often in the order a partnership agreement sets. If the property is sold or foreclosed, the senior lender is generally paid from the collateral before a junior creditor, and equity is last. That sentence is the shape of the idea. The actual order is whatever the loan documents, the intercreditor agreement, and the organizational documents say. Read those before you describe the order as a fact about a deal.

Senior debt, in ordinary income-property lending, is a loan secured by a first lien on the real estate. The lender's protection is the lien, the borrower's payments, and whatever guaranty the documents include. The rate is often the lowest in the stack because the lender is first. "Often" is not "always." A risky senior loan can be expensive, and a careful one can still be the largest check in the capital structure. Size and priority are different facts. Write both down: how many dollars, and who is in front.

Mezzanine debt sits behind the senior loan. In many commercial structures the mezzanine lender does not take a second mortgage on the land. It takes a pledge of the equity interests in the entity that owns the property. If something goes wrong, the remedy may be to take over that entity, subject to the senior loan, rather than to foreclose a junior lien on the real estate. Other deals do use a second mortgage and still call it mezzanine. The word is marketing until the collateral paragraph says what was pledged. Ask for that paragraph. Do not draw the stack from the teaser.

A labeled hypothetical stack

Use a hypothetical purchase price of $10,000,000. Senior loan $6,000,000. Mezzanine loan $1,500,000. Equity $2,500,000. The three pieces add to the price: 6 plus 1.5 plus 2.5 is 10. Suppose net operating income is $600,000. The cap rate on the price is 6 percent. These figures are a sketch so the priorities have dollars attached. They are not a quote from any lender, and they are not a building associated with any person.

Assume, for a moment, that the senior loan is interest-only at a hypothetical 6 percent. Annual senior debt service is $360,000. The senior debt-service coverage ratio, using the $600,000 income, is $600,000 divided by $360,000, or 1.67. Assume the mezzanine loan is interest-only at a hypothetical 10 percent, so it costs $150,000 a year. Cash after both payments is $600,000 minus $360,000 minus $150,000, or $90,000, before capital items and income taxes. The equity of $2,500,000 has $90,000 of cash in this static year, which is 3.6 percent of the equity check. The cap rate was 6 percent. The cash yield on equity is lower here because the mezzanine cost is high relative to the income left after the senior loan. The arithmetic is the point. It is not a prediction.

Now cut only the income. If NOI falls to a hypothetical $450,000, senior coverage is $450,000 divided by $360,000, or 1.25, and cash after both debts is $450,000 minus $360,000 minus $150,000, which is negative $60,000. The stack that showed $90,000 of cash on one income does not describe the lower income. A page that prints only the first case has hidden the second. Show both, or show the income at which cash after both debts is zero. That breakeven is senior debt service plus mezzanine debt service, $510,000 in this hypothetical. Income below that line does not support both payments.

What the papers have to say

A senior loan document, or the term sheet that precedes it, should state the amount, the rate, and whether the rate is fixed or floating. If it floats, it should name the index. The Federal Reserve's H.15 release publishes selected interest rates. A model that says "plus a spread over the index" should name the index and the spread it is using, and it should label them as assumptions when they are not yet a commitment. The paper should say whether payments are interest-only or amortizing, for how long, and what the maturity date is. It should say what happens at maturity if the loan is not paid.

It should also state collateral, recourse, and the main covenants. Collateral might be a deed of trust on the property, plus rents. Nonrecourse language, if it exists, usually has carve-outs that can still make a guarantor liable for specified acts. Do not hear "nonrecourse" as "nobody is ever liable." Read the carve-out list. Covenants may include a minimum coverage ratio, a maximum loan-to-value ratio, reserves, and cash management. The definitions decide the test. Coverage of what income, and value from which appraisal, are the questions that make a covenant either clear or surprising.

A mezzanine document should state its own amount, rate, payment, maturity, and collateral, and it should be read next to the intercreditor agreement with the senior lender. That agreement typically covers whether the mezzanine lender can take payments while the senior loan is current, how long it must wait if the senior loan is in default, and what cure rights it has. Without that agreement, a spreadsheet stack is a picture. With it, you can describe whose consent is required before a transfer, a refinance, or a change in the property. Preferred equity is a further document: it can mimic a fixed payment and still be equity, with remedies that are contractual rather than a foreclosure of a real estate lien. Call it what the contract calls it.

Loan-to-value, loan-to-cost, and the constant

Loan-to-value divides the loan by a value. In the hypothetical, the senior loan of $6,000,000 divided by the $10,000,000 price is 60 percent, if you are willing to use price as the value for the sketch. An appraisal at a different number changes the ratio. Loan-to-cost divides the loan by project cost, which matters in a development where there is no stable price yet. Using value language on a cost deal, or cost language on a stabilized purchase, mixes two denominators. Name the denominator every time you say the percentage.

The mortgage constant is annual debt service divided by the loan amount. The hypothetical senior interest-only payment of $360,000 on $6,000,000 is a constant of 6 percent, the same as the interest rate, because nothing is paying down principal. If the loan amortizes and the hypothetical annual payment is $480,000, the constant is 8 percent even if the interest rate is lower. Compare the cap rate with the constant when you want a static look at whether debt increases or decreases cash yield on equity. The capitalization rate entry walks that comparison. Do not compare the cap rate with the interest rate and stop, unless the loan is interest-only and you have said so.

Coverage and constant answer different questions. Coverage asks whether income covers the payment, and by how much. The constant asks how large the payment is relative to the loan. A loan can have a comfortable coverage ratio on today's income and a constant above the cap rate, or the reverse. Print both. The OCC handbook discusses these kinds of measures in the context of bank supervision. Your term sheet is the version that will be enforced against the borrower. The handbook does not know your spread.

Usual mix-ups

The most common mix-up is drawing mezzanine, a second mortgage, and preferred equity as one box called "gap money." They can fill the same hole between senior debt and common equity in a sources-and-uses table. They do not give the holder the same rights, and they do not put the same obligation on the property. A payment that looks identical in year one can be interest, or a preferred return that is not a debt, or a distribution that the agreement can block. The cash flow forecast should use the contract's rule for what is mandatory. The sources-and-uses table only shows where the dollars came from at closing.

Another mix-up is sizing the loan from a cap rate alone. Dividing income by a rate gives a value indication. Multiplying that value by a loan-to-value limit gives a loan amount only if the lender accepts that value and that limit. The lender may also require a coverage test, a debt yield, or an appraisal at a lower figure. Debt yield, if the lender uses it, is NOI divided by the loan amount. In the hypothetical, $600,000 divided by $6,000,000 is 10 percent. That is not a cap rate, because the denominator is the loan, not the price. Label it. A page that calls every percentage a cap rate cannot be used to size debt.

A third mix-up is treating a quoted rate as a closed loan. A term sheet can expire, can be subject to committee approval, and can change when the appraisal or the leases come in. Put the quote in the model if you want to see the shape of the stack, and stamp it "not a commitment." When the commitment arrives, replace the assumptions with its numbers. Leave the old case in an appendix if you want a record of what changed. Do not let the teaser rate become the only case anyone sees.

What the stack cannot prove

The stack cannot prove that a refinance will exist at maturity. The senior loan will come due whether or not a new lender is willing to replace it. Interest rates may be different. The building's income may be different. A mezzanine loan maturing at the same time can make the refinance larger still. Show the balances that must be paid, not only the annual debt service. A yearly cash flow that looks acceptable can sit in front of a maturity that the cash flow does not repay. The holding period entry is where that date should meet the sale or refinance assumption.

The stack cannot prove that a floating rate will stay where you set it. If you need a single case, also show a higher index. You do not have to invent a forecast. You can add a hypothetical 1 percentage point to the senior rate and recompute the payment. On the interest-only senior loan of $6,000,000, one extra point is $60,000 a year. Cash after both debts in the first hypothetical falls from $90,000 to $30,000. The exercise is a sensitivity. It is not a prediction of the index, and H.15 is the place to see where selected rates have actually been, not where they will go.

The stack cannot prove a person's borrowing history. This page does not say that Suneet Singal has borrowed on these terms or owns the hypothetical property. The career record stops at the dated roles the filings support. Use the stack to read a term sheet in front of you. If you do not have the term sheet, you have an example, and the example should stay labeled as one.

What this entry does not claim

Suneet Singal’s published professional background is in real estate and corporate finance. Company filings linked from this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. The Suneet Singal Scholarship, Grant and Giving websites describe him as the founder of those programs. This entry explains a general subject. It is not a private track record, a current job title, an investment result, or a quote.

This page is a reference, not investment advice. The equity beside the loans is often governed by joint ventures in a development, and the maturity has to meet holding period and exit assumptions.