Bridge lending is short term or interim financing that is generally used by a borrower until they secure permanent financing or sell the underlying real estate. Both the Fund and the Manager employ a collateral-based lending approach in their bridge lending activities. Under a collateral-based lending approach, a lender will evaluate a borrower’s character, credit history, capacity (income or assets unrelated to the real property), cash flow from the real property and the collateral value of the real property. However, as opposed to the approach used by credit-based lenders, who place greater reliance and weight in their underwriting decisions on the credit history and capacity of a borrower to service the loan (i.e., tax return or Form W-2 income), a collateral-based lending approach places the greatest emphasis and weight on the cash flow and collateral value of the real property. The Fund’s bridge loans will not be guaranteed by any governmental agency or private entity. Most loans made by the Fund will be collateral-based loans, generally not requiring recourse, a guaranty or additional personal property as collateral.

Bridge loans made by the Fund may be in a first lien position or subordinate lien position. 

Unlike a first lien and second lien facility, a Unitranche facility or A/B Note structure uses a single loan agreement, a single promissory note, and a single deed of trust or mortgage, and the loan is contractually bifurcated or split using an Agreement Among Lenders or an Intercreditor Agreement creating a senior piece (the “Senior Tranche” or “A Note”) and a subordinate piece (the “Subordinate Tranche” or “B Note”).  Under this structure, there is a single lien against the collateral and the borrower has a single payment obligation.  As between the lenders, the Subordinate Tranche (or B Note) functions much like a second trust deed or a credit enhancement to the Senior Tranche (or A Note).  The interest rate for the facility is allocated among the lenders disproportionately to provide the holder of the Senior Tranche (or A Note) with a lower effective interest rate than holder of the Subordinate Tranche (or B Note).  As interest payments are made under the loan they are paid to the holder of the Senior Tranche (or A Note) and the holder of the Subordinate Tranche (or B Note) based on the agreed upon allocation.  The Fund may elect in its sole and absolute discretion to retain the B Note on loans originated by the Fund or acquire B Notes from the Manager, an Affiliate or any other party.

Some of the benefits of this structure include that it can be put in place more quickly than a traditional first lien and second lien facility.  As opposed to lenders negotiating and drafting two separate sets of loan documents, the time and cost to document and finalize the transaction may be reduced through the use of a single set of loan documents.   

Mezzanine debt is a type of subordinated financing used to increase leverage in a real estate transaction. This type of debt generally fits between equity and real estate secured debt in the capital stack.  It has priority of repayment over equity but is subordinate to the real estate secured debt.  The primary benefit to the borrower using mezzanine debt is the ability to increase their leveraged returns.

Mezzanine debt is real estate-based debt, but it is not directly collateralized by the underlying real estate.  Rather, mezzanine debt is secured by a pledge of the borrower/sponsor’s ownership interest in the entity that owns the underlying real estate.  If the borrower defaults on real estate secured debt, the holder of that debt has the right to foreclose on the real estate.  Conversely, if the borrower defaults on the mezzanine debt, the holder of the mezzanine debt has the right to foreclose on the pledge of the ownership interests of the entity that owns the underlying real estate and take over the ownership of that entity.  A foreclosure on the ownership interest of the entity holding the real estate would result in the ownership of the underlying real estate through that entity subject to any real estate secured debt.  As a result, the holders of mezzanine debt may obtain higher returns than real estate secured debt and may be in a more protected position than common or preferred equity. 

Participating loans are structured as debt with equity-like economic attributes.  Participating loans may be secured in first lien position, however, participating loans are more frequently a type of subordinated financing used to increase leverage in a real estate transaction. When used as subordinated financing, this type of debt generally fits between equity and senior real estate secured debt in the capital stack.  It has priority of repayment over equity but is subordinate to the real estate secured debt.  The primary benefit to the borrower using participating loans is the ability to increase their leveraged returns at a lower cost than preferred or common equity.  Due to the lower overall cost, Borrowers may use participating loans in lieu of preferred equity in the capital stack. 

Participating loans may be directly secured by the real estate in a senior or subordinate lien position.  If the borrower defaults on a participating loan secured by the real estate, the holder of the participating loan has the right to foreclose on the real estate and take it ownership of the underlying real estate subject to any senior liens.  Further, participating loans may be structured as real estate-based debt, but not directly collateralized by the underlying real estate.  In such structures, the participating loans are secured by a pledge of the borrower/sponsor’s ownership interest in the entity that owns the underlying real estate.  If the borrower defaults on a participating loan secured by equity in the entity that owns the real estate, the holder of the participating loan has the right to foreclose on the pledge of the ownership interests of the entity that owns the underlying real estate and take over the ownership of that entity.  That would result in the ownership of the underlying real estate subject to any real estate secured debt. 

Because of the equity-like participating returns, participating loans are sometimes compared to preferred equity, which is a class of ownership senior to common equity.  The primary differences between participating loans and preferred equity are that preferred equity (1) is not a loan, and (2) continues to participate in the ownership of the real estate once the principal amount is repaid.  Conversely, once a participating loan is repaid, the holder of that loan no longer participates in any gain or appreciation in the underlying real estate.  As a result, participating loans result in a lower cost of capital to the borrower.  While having greater risk than senior secured debt, because of its priority over equity, the holders of participating loans generally have less risk than equity holders.  As a result, the holders of participating loans may obtain higher returns than real estate secured debt or mezzanine debt and may be in a more protected position than equity. 

Historically, the Fund has not invested in preferred or common equity because of the potential impacts of unrelated business taxable income (UBTI), however, the Fund may invest in preferred and common equity in the future.  See ERISA Considerations in the Memorandum.   

Common equity typically has the highest potential upside in a real estate transaction compared to other layers of the capital stack. If a transaction is successful, the common equity holders may receive large returns from the appreciation in value.  In exchange for the greater upside potential, common equity typically carries higher risk than other components of the real estate capital stack. Common equity holders are in a first-loss position and could potentially lose all of their invested capital if the transaction is unsuccessful.

Preferred equity typically has rights, preferences and privileges which are superior to common equity.  Preferred equity holders may receive preferred returns or distributions on their invested capital, which are superior and paid prior to distributions to the common equity holders.  Further, preferred equity holders typically receive a return of their invested capital prior to the common equity holders.  However, unlike debt, preferred equity is not a loan and holders of preferred equity may not foreclose on the real estate or ownership interest in the entity that owns the property.  Conversely, preferred equity holders may have the right to take control of the entity that owns the real estate over the common equity holders upon the occurrence of certain defaults.

While the form and structure of preferred equity will differ, the general features of preferred equity include (1) the ability to obtain preferred returns and distributions with higher annualized returns than senior secured debt, (2) the ability to receive a ratable share of the gain in the underlying real estate, resulting in higher annualized returns, (3) unlike participating loans which cease to participate in future gains once repaid, preferred equity holders continue to participate in future income and gains until the property is sold or their equity interests are retired, (4) it is subordinate to the debt, resulting in higher risk than the debt, and (5) it is senior to common equity, resulting in lower risk than common equity.