ULI YLG Peer-To-Peer

Equity Financings and Structures

November 2011
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ULI YLG Peer-To-Peer

Table of Contents

Section 1 What Is Equity

Section 2 Fund Level Equity vs. Project Level Equity

Section 3 Joint Venture Equity Structures

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ULI YLG Peer-To-Peer

Section 1

What Is Equity

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 ULI YLG Peer-To-Peer WHAT IS EQUITY

What Is Equity?

• There are a wide variety of

ways in invest indirectly in real
Debt Next Seminar…..
estate
• Real estate ownership is
generally comprised of both
Debt and Equity
• Equity maintains the direct
ownership interests in the asset REITs/Public Provides liquidity, but
Companies investment is subject to
• Public Securities public market investment
Ownership correlation

Real Estate
Ownership
Direct Investment Provides control and
Equity
• Direct Property benefits of real estate
Ownership diversification but
precludes market and
property type
diversification

Commingled Funds Provides geographic and

• Limited Partnership property type
interest in diversified diversification but investor
portfolio cedes control to General
Partner

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 ULI YLG Peer-To-Peer WHAT IS EQUITY

Risk – Reward Spectrum of Financing Alternatives

• Debt represents: Securities

– An obligation of the property
owner to repay; obligation
can be collateralized and
secured by the asset or
unsecured
• Equity represents:
– An ownership interest in the
company / asset
• The fundamental difference
between debt and equity is that Secured Unsecured Convertible Preferred Convertible Common
debt holds a superior claim and Debt Debt Debt Stock Preferred Equity
is repaid first
– Debt acts like a put option
– Equity is inherently riskier
and is like a call option Increasing Degree Increasing Level of
of Security Expected Return

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ULI YLG Peer-To-Peer

Section 2

Fund Level Equity vs. Project Level Equity

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 ULI YLG Peer-To-Peer FUND LEVEL EQUITY VS. PROJECT LEVEL EQUITY

Direct Investment

• Generally GP Capital
• Advantage: Single Promote
• Disadvantage: Local Expertise Institutional Investors Managing Member

90-95% of Fund Equity 5-10% of Fund Equity

Discretionary Real Estate Fund

Project Equity
25-45% of Capitalization

Real Estate

55-75% of Capitalization

Debt

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 ULI YLG Peer-To-Peer FUND LEVEL EQUITY VS. PROJECT LEVEL EQUITY

Indirect Investment

• Generally LP Capital
• Advantages: Local Expertise
• Disadvantages: Double Limited Partner General Partner
Promote

90-95% of Fund Equity 5-10% of Fund Equity

Raise a Fund
Discretionary Real Estate Fund

80-90% of Project Equity

Sponsor/Operator Real Estate

10-20% of
Project Equity
55-75% of Capitalization

Project Finance
Debt

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 ULI YLG Peer-To-Peer FUND LEVEL EQUITY VS. PROJECT LEVEL EQUITY

Real Estate Equity Alternatives

Raise a Fund Project Finance

• Raise a Fund – “Fund Equity”
• Project Finance – “Project Advantages • Ability to Close Quickly • Not Cross Collateralized
Equity” • Buying Power Through Downturns • Higher returns for strong deals

Disadvantages • Long Timeframe to Raise Money • Best Deals when Money is Tight

• Deal Pressure • Tougher to move quickly

Typical Providers • Penision Funds • Comingled Funds

• Endowments • Institutions

• Wealthy Individuals • Wealthy Individuals

Terminology • Managing Member or General Partner • Sponsor or General Partner

• Investor or Limited Partner • Third Party Equity or Limited Partner

Structure • General Partner Contribution: 5-10% • General Partner Contribution: 10-20%

• Management Fee: 1-1.5% • Development Fee: 3% of hard costs

• Preferred Return: 9-11% • Asset Management Fee: Negotiated

• Promoted Interest: Depends on Strategy • Preferred Return: 9-11%

• Acquisition Period: 3 Years • Promoted Interest: Depends on Strategy

• Disposition Period: 4 Years • Investment Term: Varied

• Clawback: Cross-Collateralized

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ULI YLG Peer-To-Peer FUND LEVEL EQUITY VS. PROJECT LEVEL EQUITY

Real Estate Fund Investment Parameters

• Opportunity – Development and the highest risk

–Strategy: Ground Up Development, Buying Notes, etc.
–LP seeking 17-19% return
• Value Added – Redevelopment/Repositioning moderate risk
–Strategy: Reposition, Renovate, etc.
–LP seeking 12-15% return
• Core – Long term hold of stabilized asset low risk
–Strategy: Stabilized asset
–LP seeking 6-10% return

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ULI YLG Peer-To-Peer

Section 3

Joint Venture Equity Structures

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ULI YLG Peer-To-Peer JOINT VENTURE EQUITY STRUCTURES

The Role of Capital Partners and Operating Partners

Alignment of Interest

• Capital / Limited Partners

– Share the same investment philosophy as the sponsor
– Institutional Investors or High Net worth individuals
– Typically provide 80%+ of equity
– Typically do not sign recourse guarantees
– Approve all major decisions (Design changes and all capital transactions)
• Operating / General Partners
– National, Regional or Local Operators
– Manage day-to-day operations of the project
– Provide recourse guarantees to the lender
– Provide all reporting to capital partner
– If a project sells for an IRR greater than the preferred return, the sponsor gets a
promoted interest.

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ULI YLG Peer-To-Peer JOINT VENTURE EQUITY STRUCTURES

Joint Venture Economics

• Structure of hurdles and promotes can be dependent on the following:

– Asset type / inherent risk
– Leverage
– Operating experience of partner
– Market competitive dynamics
• Operating partners are paid through promoted interests (i.e, dilution of Capital Partner
position) and management fees
– Sample JV terms:
– 95% / 5% deal to a 12% return for Capital Partner
– 75% / 25% deal to a 18% return for Capital Partner (Operator receives a 20%
promoted interest on top of their 5% initial contribution)
• Hurdles are based on IRR of one cash flow stream (generally that of the Capital Partner)
– Short term investments may have an equity multiple hurdle as well

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ULI YLG Peer-To-Peer JOINT VENTURE EQUITY STRUCTURES

Capital Contributions / Distributions & Fees

• Distributions
– Distributions come from Net Cash Flow and/or Capital Proceeds
– Net Cash Flow is cash flow from operations (less debt service & expenses)
– Capital Proceeds are from sales or refinancings
• Capital contributions
– Mandatory / Required Capital
– Capital for initial investment, necessary to make expenditures going forward,
shortfalls on debt service / operations
• Fees
– Acquisition fees, asset management fees, guaranty fees

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ULI YLG Peer-To-Peer JOINT VENTURE EQUITY STRUCTURES

Joint Venture Structures

• Management & Control is governed by an operating agreement on how to make major

decisions
• Typical Major Decisions: Sales, financings & refinancings, leases, budgets / approvals of
expenditures, additional capital contributions, litigation / bankruptcy, any matters outside
ordinary course of business
– Generally for 90+% partners, most major decisions are unilateral (vs. unanimous)
• Other key management issues:
– Key Man provisions
– Duties of the operating member (general partner)
– Non-compete
• Breach of other key management issues can result in removal / forfeiture events (loss of
promote, punitive dilution, etc)

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ULI YLG Peer-To-Peer JOINT VENTURE EQUITY STRUCTURES

Joint Venture Sample Term Sheet

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November 15, 2010

Mr. Apartment Developer

ABC Development Group
Any Street
Any City, Any State 12345

RE: TERM SHEET – CLASS A APARTMENT COMMUNITY

Dear Apartment Developer:

The purpose of this letter is to evidence our mutual intent to form a limited partnership (the “Partnership”) between a ABC
DEVELOPMENT GROUP entity (“ABC”) and an affiliate of PRIVATE EQUITY GROUP (“PE”) for the purpose of acquiring a 100 unit
apartment community located in ANY CITY, USA. The parties hereto agree to negotiate in good faith and proceed with due diligence to
convert this agreement (the “Term Sheet”) into an acceptable partnership agreement.

Below we have outlined how our company would like to structure the investment.

Philosophy – ABC and PE will form a partnership, which will have as its purpose the acquisition, renovation, and sale of an 100-
unit apartment community. PE will structure its position in the partnership as a Limited Partner. The partners agree that the goal of the
Partnership is to maximize investment returns and sell the project as quickly as possible for the highest achievable price.

Capitalization - We assume a total project cost of approximately $20,000,000, and a loan for $15,000,000, leaving an equity
requirement of $5,000,000. PE will contribute 90% or $4,500,000 of cash equity to the joint venture. ABC will contribute the remaining
10% of cash equity required or $500,000.

Preferred Returns - The PE and ABC cash equity contributions will be treated equally, and both will earn a preferred interest
rate of 10% beginning with PE’s first equity contribution. The preferred returns will accrue and be payable from project cash flow. All
preferred interest will compound annually.

Payments to ABC - ABC will be paid an acquisition fee of 1% of the Total Budget (exclusive of the fee itself). The
acquisition fee shall be paid upon acquisition of the project.

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PE Equity Fee – Simultaneously with the acquisition of the project, PRIVATE EQUITY GROUP shall be paid, an equity fee of
1% of total project cost exclusive of the fee itself. This amount shall not be treated as a return on or return of the PE capital, or as any
other capital contribution to the Partnership.

Distribution Priority - Any ordinary cash flow remaining after payment of debt service on the Loan and establishment of a
$300 per unit per year replacement reserve fund (“Net Cash Flow”) and any extraordinary cash flow proceeds from the sale, refinance or
other liquidation of the property after full payment of the first mortgage loan (“Extraordinary Proceeds”) will be distributed as follows:

First, repayment of loans or excess capital contributions made by partners, plus a return.
Second, to the Partners, pari passu, in payment of each Partner’s accrued, but unpaid, 10% preferred return on initial cash investments.
Third, to the Partners, pari passu, to return their initial cash investment.
Fourth, to each Partner, as set forth in the Ownership Section below.

Ownership - After distributions are made in accordance with the distribution priority section above, all Net Cash Flow and all
Extraordinary Proceeds will be distributed 75% to PE and 25% to ABC until PE has achieved an 18% IRR. Distributions above an 18%
IRR and up to a 22% IRR shall be distributed 60% to PE and 40% to ABC. Returns above a 22% IRR shall be split 50% to PE and 50% to
ABC.

IRR Calculation – The IRR is calculated using the “= IRR” function in a Microsoft Excel spreadsheet applied to a schedule of
the actual monthly cash contributions and distributions for PE. All contributions and distributions are assumed to be made on the first of
the month nearest the actual date made. The resulting monthly percentage calculated by the “= IRR” function is then multiplied by twelve
to arrive at an annual percentage.

Major Decisions - PE will leave day-to-day management of the partnership to ABC. PE will retain the right to approve all
major decisions, including those decisions that affect the design and specifications of the project, as well as those that involve any capital
transactions, including a sale or refinance.

Defaulting and disabling Events - The partnership agreement will include definitions of “defaulting” and
“disabling” events, such as failure to honor the guaranty of non-recourse carve-outs under the mortgage loan, misappropriation of
Partnership funds, withholding distributable cash flow, bankruptcy of a partner or guarantor, the transfer of a partner's interest or
withdrawal of a partner from the Partnership in violation of the partnership agreement.

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Upon the occurrence of a defaulting event by ABC, all fees payable to ABC will cease, PE may elect to terminate any ABC affiliate
contract, and PE will have the following rights listed below:

Key Personnel Default – If there is a change in control of the General Partner or if the persons in control of the General
Partner cease having direct or indirect control of the General Partner or withdraw as members or partners of the General Partner, PE will
have the right to replace ABC as the General Partner and to convert the interest of ABC to that of a limited partner without any decision
making rights.

Bankruptcy – If ABC or any of the Guarantors files for bankruptcy, then PE will have the right to replace ABC as General Partner
and to convert the interest of ABC to that of a silent limited partner without any decision making or voting rights.

Fraud and other “bad boy acts” - Misappropriation of Partnership funds, withholding distributable cash flow,
violations of Partnership transfer restrictions, and other willful misconduct or gross negligence by the General Partner will result in a
termination of the General Partner’s interest in the Partnership, and such right to terminate for “bad boy acts” will be secured by a pledge
of the General Partner’s interest in the Partnership.

ABC agrees that until this Term Sheet is terminated by mutual agreement of the parties hereto, ABC will not conduct negotiation with any
other potential investors regarding the transaction described in this Term Sheet and will terminate any current negotiations with respect
thereto; provided, however, that the foregoing covenant by ABC shall terminate and the provisions of this term sheet shall automatically
expire in the event the parties have not executed a Partnership Agreement by December 15 , 2011.

Please note that PE will require final Advisory Board Approval for this proposed joint venture. We understand ABC’s approval is subject
to its own process as well.

This Term Sheet is not intended to constitute a legally binding contract between the two parties and the terms contained are subject to the
satisfactory completion of our due diligence including, but not limited to, receipt and approval of:

Engineering and environmental reports;

A copy of the purchase contract;
A copy of the partnership agreement and all related documents;
Copies of all due diligence materials provided by the seller;
A detailed marketing and leasing plan for the project;
Plans and specifications including the community amenities, unit amenities, clubhouse interior design and FFE;
Construction capabilities audit to be performed by PE’s Construction Management Team;
All loan, bond, title, and other related documents.

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We look forward to finalizing this proposal with you.

Sincerely yours,

PRIVATE EQUITY GROUP

By:_________________________________ Date:__________________
Mr. Capital Partner
Managing Director

This Letter of Intent offer is accepted by Sponsor:

ABC DEVELOPMENT GROUP

By:__________________________________ Date:__________________

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