chapter 10: capital structure Flashcards
capital structure
The types and amounts of capital that are employed to finance a property
optimal capital structure
The capital structure that achieves the maximum return on equity
asset’s capital stack
the claims against an asset and the layers of capital
which claim has the first right to receive operating cash flow and proceeds from a sale or liquidation?
The most senior claim
typically a first mortgage
disadvantage of having the senior claim
also carries the lowest return
which is the most senior claim on cash flow?
the fixed dividend on preferred stock
the most junior claim on cash flow
the dividend on the common equity
when you sell property, the full principal amount of all debt, along with any accrued interest, must be paid prior to what?
prior to any proceeds being distributed to the equity holders
what happens when the sale of property does not bring enough money to repay all the debt
it must be paid in order of seniority
if a junior claim has a maturity date earlier than the senior claim, who has priority on the repayment on debt?
the junior claim
WEIGHTED AVERAGE COST OF CAPITAL (WACC)
the combined cost of the debt and equity employed to finance a property or entity
combines the cost of debt and the cost of equity in proportion to the amount of each present on the balance sheet
how to calculate the weighted average cost of capital)
(Kd · D) + (Ke · E) - t
Kd: cost of debt
D: debt
Ke: cost of equity
E: equity
t: marginal tax rate
how can negative leverage turn positive? can the opposite happen too?
if a property’s NOI improve
ye if property performance buggs
who own the residual rights to all cash flow and liquidation proceeds after the creditors have been paid?
Equity holders
what is the equity’s holder claim limited to?
It is limited only by the performance of the property
why is leverage employed?
Leverage is employed to increase the yield on equity
how does leverage increase the yield on equity?
If the return on the asset (ROA) is greater than the cost of debt (Kd)
how does leverage decrease the yield on equity?
If the return on the asset (ROA) is lower than the cost of debt (Kd)
how does one calculate leverage?
leverage = D / (D + E)
how do you calculate ROA?
EBITDA/Total capital
EBITDA
Earnings before interest, taxes, depreciation and amortization
what is an after tax interest rate
the result of the property owner being able to deduct interest paid when calculating income subject to taxation
when would you want a negative leverage?
Expect NOI to Grow
Need Cash to Acquire property
when does the portion of a property’s operating cash flow required to service debt increase?
when the level of leverage increasea
Mezzanine debt (mezz)
provides an additional level of capital beyond traditional senior secured or first mortgage financing
has more flexible covenants
has a higher level of risk than traditional financing and requires significantly higher return
serves as bridge financing
how does mezzanine financing serve as bridge financin?
it has short maturity
has an expectation that the mezz will be refinanced once a new capital structure is implemented following asset stabilization or turn around
when does the availability of mezz tend to diminish?
in troubled real estate markets
Wrap-Around Debt
you already got a first mortgage, but another mans gives you a second one
when the maturity of the first comes to an end, the second mans pays for it, making him the only man you owe to both debts
Participating Loans
give the lender an additional return based on the performance of the underlying asset
what is the additional return of a participating loan based on?
annual operating performance
proceeds from enhanced valuation at maturity
or both
Fixed participations
generally stated as a set percentage of profits after payment of the base interest rate
Variable participations
call for the lender to be paid a variable percentage of earnings before taxes and net sale proceeds
The percentage depends on how well the property performs
Convertible Loans
allows the lender to exchange all or a portion of their note for an equity interest in the asset
if the asset performs poorly, the lender will seek a return of their principal at maturity
If the asset performs well, the lender will convert their note into an interest in the asset
preferred equity
receive dividends and liquidation proceeds before any funds are paid to common equity holders
senior to common equity
dividends paid at stated rate which is bigger than the ones of common shares
this dividend remain the same amount over time, while the latter could boom with gyu performance
cumulative preferred equity
Securities with an accumulation feature
conversion rights
allow the preferred shares to be exchanged into common shares at a set exchange ratio
Some preferred equity structures may include this
what are hybrids used for?
used to provide leverage for common equity holders beyond the level where traditional secured financing sources are prepared to lend
given higher returns for the acceptance of the additional risk that comes with being subordinated to the senior lien holders
sale leaseback
a transaction in which a property owner sells his or her asset to an investor and then leases it back from the investor
benefits of a sale leaseback
allows the property owner to access the capital invested in the asset for other purposes while still maintaining the use of the property
may also include a right for the seller to repurchase the asset at the end of a given period
which types of properties are the best candidates for sale leasebacks
Corporate headquarters, chain stores, and restaurants
bargain purchase clause
The price to reacquire the asset sold after a sale leaseback might be set at a low level to encourage the user to repurchase the property at the end of the lease
land lease
ease a parcel of land under a long-term agreement that allows the lessee to build and utilize a structure on the land
subordinated ground lease
If the land lease is made junior to the bank loan on the structure
unsubordinated ground lease
. If the ground lease is senior
why are unsubordinated ground leases very safe investments?
because neither the owners nor lenders on the improvements are likely to lose their assets to the ground lessor through a default
why are subordinated ground leases a riskier investments?
because in order to preserve ownership of the ground, a lessor may need to repay the first mortgage on the improvements
air rights
he property owner’s rights to develop additional space, typi- cally vertically, on an existing building
mineral rights
the property owner’s rights to exploit any minerals that are located on a property
Oil and gas rights
owner’s right to explore for, drill for, and exploit hydrocarbon reserves
Water, riparian, and littoral rights
the ability of a landholder to use the water and the shoreline on or adjacent to their property
