REAL ESTATE SENIOR MEZZANINE DEBT FUND LP
[●] 2020
Re: Consent Request
Dear RE Senior Mezzanine Fund Investor,
I am aware of your readiness to invest in the fund. However, due to circumstances beyond our control, I seek a modification of the investment strategy. Notably, I propose we raise the funds through loan originations. This letter therefore seeks your consent for the said modifications.
Background
The unprecedented events related to the COVID-19 outbreak have impacted the Commercial Real Estate Lending market in considerable ways. Among other impacts:
- The COVID-19 crisis has caused many lenders, including CMBS lenders, to pull back from originating new loans.
- The lack of bank lending activity extends to warehouse facilities that many non-bank lenders have utilized to leverage loans to either aggregate for sale or securitization or to increase returns.
- These bank lenders had been the main source of debt that the Fund had been acquiring and their lack of origination, should it continue, would make it challenging to acquire new Investments through the secondary market.
- However, this lack of lending activity may provide opportunities for some non-bank lenders, such as debt funds, to originate loans on quality real estate to strong borrowers which would normally borrow from banks under normal market conditions.
In order to take advantage of these opportunities, the General Partner believes that the Fund should have the ability to originate whole loans.
- Originating loans will allow the Fund to create investment opportunities that are not currently available in the market on price and structure terms that the Fund determines.
- Reduced competition is expected to allow the Fund to be in position to originate loans with structures and coupons that are expected to be accretive to returns without materially increased risk compared to Investments acquired through the secondary market.
- We are already seeing opportunities to lend on multifamily and industrial assets with accretive returns and loan-to-value (“LTV”) levels that are in-line with the current portfolio’s average LTV.
- These loan types previously traded at levels below the Fund’s target returns and/or had been more loosely structured and potentially added risk to the loan.
- Assuming this modification is approved, the Fund will seek to originate loans primarily on new acquisitions with true cash equity going into the property from the sponsor (i.e., no “cash out” re-financings).
- In addition, the Fund would be expected to originate loans with respect to multifamily, industrial and office properties; the Fund may, but does not expect to, originate loans with respect to retail assets and will not originate loans with respect to hotels or similar assets.
The proposed modifications to the investment strategy are attached as Exhibit A.
Exclusion from Originations
You understand that you must do appropriate due diligence on the proposed modifications before deciding to commit yourself. Accordingly, you are free to opt out of the fund at your discretion, if you are not comfortable with the proposed modifications.
Also note that you may not raise investment restrictions, which may materially modify, and negatively impact the proposed investment strategy.
Request for Consent
In light of the foregoing, it is incumbent upon you to make a decision to either give your consent for the modifications or withhold it.
You understand that your consent rights offer an important way to safeguard your investment from potentially costly decisions that, without such consent rights, could be made by the General Partner without any consultation. Accordingly, your consent hereby will go a long way to protect the value of your investments in the fund.
Sincerely,
Real Estate Senior Mezzanine Debt GP LLC
Re: Consent to Proposed Modification to Investment Strategy
PLEASE RETURN BY EMAIL AT [●] BY [●], 2020.
Exhibit A
Proposed Modification to the Fund’s Investment Strategy
(Deleted text is struck in red and additional text is shown double underlined in blue)
Exhibit B
Certain Risk Factors Associated with Loan Originations
The risk factors and potential conflicts of interest described in Section VIII of the Offering Memorandum are hereby incorporated by reference. Investors should consider that disclosure along with the following before deciding whether to participate in the Fund’s loan origination investments:
General Economic and Business Conditions. .
First, as Mezzanine investments are mostly made into founder or family owned companies, these companies tend to not have the seasoned management teams that are found in large corporations. Due to their size they often also have a lower standard of governance and financial reporting. Therefore, loss of a customer or increases in the cost of raw materials may have a larger impact on the earnings before interest, taxes, depreciation and amortization (EBITDA), than it would on a larger company.
Second, an investment into a mezzanine instrument is a long-term investment and is hard to sell or liquidate prior to its maturity. While there is a quicker return on capital, you may have very limited alternatives in terms of exiting the investment before its due date.
No Assurance of Investment Return; Loss of Entire Investment.
The nature of the investment raises the cost of capital up. Accordingly, Mezzanine debt investments come with higher interest rates, which mean that the property has to produce more cash flow to pay for the debt service.
A mezzanine loan also comes with high fees. Again, this increases the total cost of capital, which means that the property has to perform well enough to service all debts.
Also, Mezzanine debt is generally subordinated to the senior debt in a company and will usually only have second lien security over the assets. In the event of a default, a lender is only protected to the extent that the value of the company does not decline by more than the amount of its equity and other guarantees provided to the lender. It follows; for instance, in a bankruptcy or foreclosure, there may or may not be enough to be repaid in full.
Availability of Loan Origination Investments.
Several factors may affect the availability of loan origination investments. These include the level of government regulations in the sector and economic constraints. One reason that has contributed to the survival of loan origination investments is the relatively lightly regulated framework, compared to other financing options. It follows; strict regulation will hamper the growth and spread of loan origination investments. On the other hand, economic constrains may affect credit risk, thus bearing a direct impact on credit financing.
Licensing Requirements.
Title 5 of the Delaware Code § 2202 provides that every person desiring to transact the business of lending money in Delaware shall be required to obtain a license. However, the said section proceeds to provide that a person that makes not more than 5 loans within any 12-month period shall be deemed not to be transacting the business of lending money, and loans made by such unlicensed lender shall fall under Chapter 23 of Title 6 of the Delaware Code.
For a licensed lender, the process begins with filling an application for a license and payment of required fees which include an investigation fee and the annual license fee upon approval. See Title 5 of the Delaware Code § 2203.
Fraud.
The adverse effect of fraud on credit investments cannot be overemphasized. There are very many instances of fraud in credit lending. Web scrapping, for example, happens when fraudsters set up fake accounts to lure individuals into giving away sensitive information, which is then used to steal identities or apply for loans using application fraud techniques. Account Hacking, a more nefarious form of lending fraud, involves hacking into the bank account of an individual and applying for a loan on their behalf.
Thirdly, loan phishing scams happen when fraudsters send an e-mail to unsuspecting individuals purporting to be their bank or other financial institution. The fraudsters then attempt to get the e-mail recipient to click a link and enter account information into a site designed to look like the victim’s bank website. Such schemes defraud the unsuspecting victim then defraud the lending institution as the information gatherer uses that falsely acquired information to apply for a loan and then run off with the money.
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