There’s no HELOC equivalent in commercial real estate—here’s how to access equity instead

Tim Milazzo
December 29, 2022

A Home Equity Line of Credit (“HELOC”) is one of the most popular financial products available for homeowners who have built up equity in their house. It’s a convenient alternative to a full refinance of the house - instead of pulling cash out and paying interest on the full amount, homeowners only pay interest on the portion of the credit line they draw on.

Unfortunately, HELOCs do not exist for commercial properties. There’s really no commercial real estate equivalent to the HELOC.

That doesn’t mean there’s no way to access your equity for a commercial property, though.

But first, why this financial product, which I suppose would be called a CPELOC (Commercial Property Equity Line of Credit) if it did exist, isn’t a reality.

Why HELOCs don’t exist for Commercial Real Estate

The first thing to understand is that commercial financing, in general, is structurally different from residential financing. In the residential mortgage market, the home owner typically takes out a loan for a 15 year or 30 year term, and equity slowly builds during that period. The underwriting revolves around the borrower’s personal credit.

In commercial real estate, while the borrower’s financial picture is a relevant data point, underwriting really revolves around the property. Loans are usually not such long-term fixed arrangements as are residential mortgages. The market for commercial real estate investment is also not as liquid as residential real estate in many cases, nor are most loans government-backed. It’s a different risk assessment than giving a consumer capital against their home equity, and would make it hard for the lender to deal with a default.

Strategies for accessing equity for commercial investment properties

There are several methods of accessing pent-up equity in a commercial real estate investment property that has an existing loan. Here are some of the most common methods.

Mezzanine debt

Mezzanine debt, often referred to as “mezz”, is a common type of subordinated debt. It is a higher risk loan than a typical senior commercial mortgage, as the senior loan has the right to be paid back first.

Mezz loans have higher interest rates and more covenants than conventional commercial loans. However, borrowers often look at the blended cost of capital when considering this type of subordinate debt, or compare the cost of mezz to the expected return of their equity. If the all-in cost of the mezz is lower than the expected return on equity, that’s still positive leverage.

In order to take a mezzanine loan on a property, it must be allowed by the senior lender through an intercreditor agreement. This is uncommon for local banks and credit unions to allow, and becomes more common with larger deal sizes and sophisticated sponsors.

Preferred Equity

Preferred equity, often referred to as “pref”, is similar to mezzanine loans in that it is capital that sits between the senior loan and the sponsor’s common equity. However, preferred equity is not structured as a loan and does not require an intercreditor agreement with the senior lender.

Preferred equity is commonly structured with a current pay component called a Preferred Return, where the Preferred Equity investor gets paid the first 8% or 10% return on equity, and then takes a smaller percentage of the Promote, which is the split of the rest of the equity returns. The Preferred Return may also be Accrued rather than Current Pay, particularly for construction or major renovation projects with limited short term cash flows.

Loans against GP/LP Equity

Individual investors in cash-flowing properties can also take out a minority loan against their equity interest directly in certain cases.

There are niche capital providers for commercial real estate investors focused on this type of liquidity, regardless of whether the investor is a General Partner (“GP) or Limited Partner (“LP) in a given deal. This does not affect the senior lender on your property, or other investors with equity in the deal. They simply lend against your ownership stake and collect interest payments from your capital distributions in order to give you more liquidity today.

While convenient, this is most often not the cheapest option for accessing equity compared to other methods of financing.

Cross-collateralized loans

Another route to utilize the equity built up in a commercial property, though not necessarily to withdraw it, is to cross-collateralize.

If an investor needs capital for another property acquisition or project of some kind, a cross-collateralized loan will issue a lien against the property that has equity built up in order to supply capital to the new deal. The underwriting for this type of financing can become complex, and usually starts with an analysis of the borrower’s Schedule of Real Estate Owned to determine potential assets to cross-collateralize.

Cash-out refinancing/Recapitalization

These last two strategies differ from above. They do not preserve the senior loan on the property.

The first is to refinance the senior loan on the property to take cash out. If the new loan has a higher net loan amount than the old senior loan, the difference is returned to the borrower.

Sell the property

Selling the entire property is the final, ultimate way to access equity in a property. While other methods of recapturing capital preserve ownership, they also only access a portion of the capital that is owned. Selling is (usually) the only way to retrieve the entire equity portion of the capital stack.

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