It happens every day: A real estate developer with a vision for a new project drives to his city's financial center and looks wistfully at the shiny bank towers that house lavish investment firms, knowing full well that these firms will be completely uninterested in his project. Then he'll visit three or four private investment organizations that specialize in seed money for start-up real estate projects.
If he is lucky, the developer's project will be looked at favorably by these hard-cap lenders and the seed money will be made available, but that's rare. There in a nutshell is the bottleneck of real estate innovation. The good news is that an emerging group of so-called orchestra firms are bringing a new spark to real estate visionaries.
Orchestra seed loans were historically known as hard capital or hard-money loans, but the word “hard” has been discarded because it unduly implies reluctance and risk on the part of lenders and borrowers. Mezzanine and bank loans provided by traditional lending institutions often follow seed capital, so the word orchestra has become a nice fit for the modern lending organization specializing in seed capital. Such a capital structure is comparable to theater seating, where the orchestra comes before the mezzanine.
Orchestra firms represent a new breed of sophisticated seed-level lenders who are on a par with the major public institutions. More than simply making short-term acquisition loans, first mortgages and development loans, these firms are bringing technical, geographic and marketing expertise that is providing invaluable support to developers.
When a Seattle developer was having trouble getting financing from traditional lenders for a proposed upscale 100,000 sq. ft. mall because the city government showed only a tepid interest, the developer approached an orchestra lender. The lender determined that the city might be more excited about the project if one of the potential tenants was a high-end food emporium. The lender and developer targeted the ideal tenant so that when a relationship with a top food chain was forged, the loan, and the city approval, went through with flying colors.
Similar to mutual funds, orchestra funds seek outside investors who pool their capital to lend to developers. The funds are typically designed to generate profits by making acquisition loans, first mortgages, and development loans. Most funds will also specialize in a particular geographic region.
Personal investors will find these funds attractive not only because they are about the only way for them to participate as lending sources, but also because they will achieve a relatively secure return of about 13% on an annualized basis.
The beauty of orchestra funds is diversification, or the spreading of risk across a wide variety of investors and projects. More investors will be able to participate because these funds require far less initial investment than if they were to finance a project individually. For the borrower, this vehicle will ultimately provide a new and less expensive funding option. As more real estate players get involved in orchestra lending, more capital will be available for worthy projects, and expenses such as interest-rate costs will decrease for the borrower and lender.
Until recently the typical entry-level orchestra investment was a minimum of $500,000. Today, thanks to orchestra funds the minimum has dropped to $100,000. As orchestra funds become more popular, it is our hope that the individual real estate investor will be able to participate in this type of lending for as little as $10,000.
When a Phoenix developer learned that an exciting urban redevelopment opportunity was about to hit the market, he knew that if he did not secure a loan within a few days the feverous bidding by developers across the country would make the project's costs unreasonable. The developer approached an orchestra fund manager with similar investment objectives. The fund manager recognized the value of the deal and moved on it quickly. Ultimately, the loan was secured and the development was a success.
Orchestra lenders and funds are the new frontier in real estate. As interest rates rise and capital diminishes, the quality companies will rise to the top and be even more important to investors and developers. Orchestra companies and funds seek to add growth, value and innovation in the once staid, and much misunderstood, world of hard money — a term that may have seen its last days.
Jason Moskowitz and Michael E. Napoliello Jr., who developed one of the first orchestra funds, are executive officers of InSymphony Private Capital (www.insymphony.us.).