Banks are required to hold a fixed percentage of cash against different types of commercial real estate loans, while private-equity funds have more flexibility when it comes to capital reserves.
If an issue in underwriting and due diligence arises, then private-equity funds can, in many cases, work around the issue or offer more flexible solutions than traditional lenders.
When a deal does not work with private-equity debt alone, it might still qualify for joint-venture equity, or both.
Traditional lending sources often are restrictive on where they are willing to lend. Large banks often focus only on major markets, and regional and local banks require deals within their region.
This requires national borrowers to have a network of different banks across the country when using traditional capital. Having multiple lenders can result in decreased efficiency, longer processing times, and increased paperwork and risk.
Private-equity funds are less restrictive on location, which allows national borrowers to partner with the same private-equity company on their entire pipeline.
When the borrower has already been underwritten, the process times and paperwork on each deal shrink significantly, and loans can close faster. In some cases, a deal may not qualify for private debt because of credit issues.
Private-equity funds can still make the deal happen by providing joint-venture equity. Because of the difference in structure between private debt and joint-venture equity, the latter can mitigate some of the concerns that are difficult to overcome with private debt.
The cons of private-equity debt are the cost of capital and generally shorter terms. Private-equity funds require a higher cost of capital to generate accretive returns, or post-transaction value, for the fund investors.
The lifecycle of private-equity capital is usually shorter than its traditional-lending counterparts. As a result, private-equity funds are not likely to provide long-term permanent loans. Private-equity funds, in most cases, will be pushing the borrower to repay the loan in less than 36 months.
Private-equity funds find debt financing attractive because it offers consistent cash flow and it offers less risk than joint-venture equity investments.
Debt financing provides an opportunity for these funds to get a decent yield and, in some cases, returns similar to mezzanine debt.
Going forward, private-equity debt should be an increasing and reliable source of short-term funds for borrowing in cases of a nontraditional loan request.
Counts, Stephen, and Ralph Cram. "Private-Equity Debt Can Save the Day." Scotsman Guide. http://www.scotsmanguide.com/Commercial/Articles/2017/08/Private-Equity-Debt-Can-Save-the-Day/.