Florida Real Estate Primed for Wave of Private Equity Financing

As real estate has boomed in Miami, a growing number of private equity firms looking for ways to deploy cash reserves for a better return on their investment have started financing real estate projects, a trend attorneys expect to continue not just in South Florida but also in Orlando and other metro areas across the state.

Private equity firms have become a popular alternative source of funding for developers in Miami, particularly those that don’t have the track record of success necessary to meet a bank’s strict underwriting standards or that need the cash quickly and don’t have time to wait for a bank, attorneys say.

“What we’ve seen now is an active lending market by private equity funds,” said Jay Sakalo of Bilzin Sumberg Baena Price & Axelrod LLP. “They’re an alternative source of lending for developers.”

The recession drew a number of private equity firms into Miami, where they bought up distressed properties in bulk and invested in real estate in a more traditional manner, according to Marc Shuster of Berger Singerman LLP. They were able to buy these properties inexpensively, rent them out and make a significant return for investors.

But as property values went up, and returns went down, the funds began to look for other ways to put their money to work, he said. Working as a lender is a great way to see a good yield, according to Shuster.

“Beginning in about early 2014, the funds began to think: We can be a safe-bet lender and continue to put money to work,” Shuster said.

The upside for the borrower is that these funds are not regulated as heavily by the government as banks are, so their underwriting practices are not as stringent. The money comes faster, and they are more willing to take risks on unproven, new developers, whereas a bank might require a list of past successes before executing a loan. Shuster says he has seen funds execute on debt in a matter of a couple of weeks.

“You’ll never see a bank do that, but they aren’t set up to do that,” he said. “They have an underwriting and internal review process and safeguards.”

The private equity loan, however, comes at a higher price than a bank loan. The difference in interest rate between private equity money and a traditional bank loan can be as little as 3 percent or 4 percent, though it fluctuates depending on the type of deal, according to Sakalo.

Brian Belt at Gunster Yoakley & Stewart PA said private equity loans are often used as transition funding to acquire property until the construction funding falls into place. A small private equity lender can move quickly to help get a developer cash while waiting for more traditional funding, he said.

Sakalo said he often sees private equity financing used as an initial construction loan that is pegged to the start of lease revenue.

In South Florida, the Blackstone Group LP has recently loaned hundreds of millions to Hollywood condo-hotel project the Hyde Resort & Residences, to a similar project in Surfside at the old Surf Club site, and to Biscayne Beach, a 51-story condominium project in Miami’s Edgewater neighborhood.

Canyon Capital Realty Advisors LLC also made a $157 million senior construction loan to finance the development of the SLS Brickell Hotel & Residences in Miami’s financial center.

The private equity firms are filling a void in the market for funding somewhere between the “buttoned-up” traditional bank loan and the “really loose hard money capital” that comes at a high price, according to Daryl Shevin, the CFO of 13th Floor Investments, a Miami-based private equity-style real estate investment trust.

“At some point, various groups realized there was a gaping hole in the market,” he said. “It’s a really nice niche being carved out.”

For a company like 13th Floor, which has worked as a developer, an investor and as a lender, the few extra risks that a bank won’t take can often be worth the potentially higher upside, Shevin said.

And the downside — potentially owning a property after a default — is not so bad, he said. Whereas a bank does not want to ever end up having to take control of an asset after a defaulted loan, a private equity firm that is skilled in real estate can more quickly make something of the asset and start seeing a return on the investment.

“If a bank makes a loan and ends up owning the real estate, that’s a big problem,” Shevin said. “If a real estate-focused private equity firm makes a loan and ends up with the property, the view is ‘Eh, worse things can happen.’ You’re able to get a little more aggressive. We hope our borrower knocks it out of the park, but having a skill set like ours allows us to take a different position.”

Private equity financing has taken hold in Miami and in other major markets in the country, but Shuster said it’s now starting to happen in secondary and tertiary markets. In Florida, that means places like Orlando and Tampa might begin to see more deals like this.

“I think as some of the prime markets get saturated, they’re going to look to some of the smaller markets,” Belt said.

“I think you might see the private equity players or the private lenders move a little more quickly to those markets than the banks. They’re more agile.”

But if the federal government begins to add regulations to private equity funds, they may not be able to remain as agile. Belt said the U.S. Securities and Exchange Commission is looking into these firms, and he expects some more scrutiny in that area. He added that private investors are also paying closer attention and adding their own level of scrutiny.

Raul Garcia of accounting firm Kaufman Rossin said that the real regulation for private equity funds is coming from the tax side. But if something goes wrong, he said to expect the SEC to add some regulation.

“When there’s a blowup and the right person gets burned, you’re going to start seeing regulations,” Garcia said.

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Raul A. Garcia, CPA, is a financial services principal in Kaufman Rossin’s Miami office. Kaufman Rossin has been recognized as one of the best CPA firms in the U.S. Raul can be reached at rgarcia@kaufmanrossin.com.