My 2 cents on investing through a loan: Recently, several failed projects have made headlines...

2 My cent on investing through a loan:

Recently, a number of failed projects have been headlined by Israeli investors investing in real estate abroad. There is no way to know exactly what each of these projects has invested in, and indeed every investment has a degree of risk. It is important for me to expand on one specific point: one of the most prominent real estate investment vehicles in the US is not real estate investment, but loans. Investors lend money to local entrepreneurs for the equity of the entrepreneur needed to obtain a loan from the bank.

An entrepreneur in the US who receives a loan from the bank for the purpose of executing a project at a certain height (say 70%), is required to complete the balance of the equity (say 30%). These loans are called "Mezzanine" loans.

The benefits of such a loan to an entrepreneur are that it can increase its volume of activity and leverage its equity for larger projects, or a larger number of projects, by increasing initial equity. The disadvantage to an entrepreneur is that such a loan is a significantly expensive loan from a bank loan. If a bank gives the entrepreneur a loan of around 6%, then the Mezzanine loan interest could also reach 12%. Sometimes there are agreements where the Mezzanine loan providers also benefit from a profit analysis, if necessary.

The advantage to lenders is, as noted, that the loan will happen, meaning they receive high interest rates, and sometimes even generate additional profit from project profits. The downside to lenders is that the collateral they receive for securing their money is low in the order of creditors, and this is detailed:

Of course if everything works out well - it's great and everyone is generous. At the end of the day Mezanin loan is a legitimate loan. But if there is a project failure, or then a problem arises. In the case of bad planning, even a failure of another project can cause a problem for all projects of the developer.

In every investment it is important to check the "WORST CASE SCENARIO" - what will happen in the worst case? If we give a loan, we must take into account that we will have to realize the assets, that is, sell the assets of the borrowing company at a higher price and return the money given to the entrepreneur.

Without over-elaborating, I will note that when realizing corporate assets there is a ranks for who comes first and who comes after (what is left), etc. This is called order of credit.

In that order, right after state taxes - the bank is always first. If the bank is not immediately after the state - no loan.

That is, if the assets need to be realized - first of all the state will receive its share, ie taxes. The bank will receive all the money it owes, including related expenses, only to the state. What remains, if left, will go to the queue, in our case, the lenders of the Mezzanine Loan, other creditors and the original entrepreneur.

Assuming the project has a reasonable profit margin and really money remains after the bank has taken its share - now lenders need to charge their share. However, it also does not come for free, as an attorney must, and there will usually be other creditors who will contest the same share, so in many cases what happens is a haircut. Lenders get some of the original loan provided they get something back.

In summary, equity loans to entrepreneurs are not really investment in real estate, they are more investment in real estate. They are more risky than investing in real estate because of weaker collateral, and usually do not enjoy the additional benefits of investing in real estate, such as value increase, loan fund savings, etc. In addition, being a lender is a profession that requires an orderly "failure" mechanism that allows lenders to realize the company's assets on an order day, and of course the ability to assess the risk as well as the actual costs themselves.

At the end of the day - the best bet is to own the property you are investing in.