Is there Enough Rescue Capital to Stave Off Distress?

Last week I penned a piece discussing how and when transactional velocity will return to the market. There is so much we still don’t know about the current macro-economic environment and of course the real estate investment market, but one thing we do know is that the market will come back. One of the points I made: “That as transactions increase in number the first wave will be dominated by recapitalizations and structured transactions where the equity feels like debt and is somewhat insulated” bears further discussion. From a technical standpoint, what I am really referring to is what has commonly become known as “Rescue Capital”. Much has been made about the vast amount of rescue capital that has been raised and is still accumulating on the sidelines and is becoming poised to jump into the market when the time is right. 

First, let’s discuss precisely what the term “rescue capital” refers to: Generally, when the term is used it refers to an investment that is structured as preferred equity that is intended to be true equity for investment and tax purposes, but has more debt-like features than traditional equity. Without getting too technical, an infusion of rescue capital typically comes along with a reconfiguration of the existing asset level capital structure. The new capital will likely relegate the existing investors to the bottom of the stack and will have voting rights and control provisions that exceed that of a typical preferred equity position. In some cases, the lender will also need to make concessions that could include loan resizing, but a foreclosure is avoided and the owner retains control. It can be a way more efficient and cost-effective way to recapitalize an asset this way as opposed to having it run through a process where there is a foreclosure or bankruptcy which in many jurisdictions can add as much as 7% in various taxes before new equity is even applied to the property. Of course if the deal performs well over time the owner can even make some of their equity back and in some cases get a return. Each situation is different, but these types of deals can be incredibly valuable for a property that has positive cash flow but cannot be refinanced in the current environment, requires capital for improvements, or simply is in need of an expensive rate cap.