There are numerous different fund financing products to meet the financing needs and objectives of real estate funds, affiliated investment vehicles and stakeholders at every level of the fund structure and every phase of the fund life cycle. This article provides an overview, including a summary of certain key characteristics and advantages of each product.

Introduction

The COVID-19 pandemic has had a severe negative impact on the commercial real estate market. As of the publication of this article, real estate values are down in some sectors by as much as 25 percent, vacancies are up in certain sectors by almost 15 percent, and bankruptcy filings have significantly increased, with even more expected in the coming months. Many private real estate investment funds[1] view the current economic climate as an opportunity to invest in an abundance of distressed and opportunistic real estate assets.

For real estate funds, third-party debt financing can provide capital to take advantage of investment opportunities, meet financing needs and achieve other objectives. This article provides a brief overview of the primary fund financing products for real estate funds and related parties:

1. subscription credit facilities;
2. umbrella credit facilities;
3. management fee lines of credit;
4. partner loan programs and general partner lines of credit;
5. net asset value credit facilities;
6. hybrid credit facilities; and
7. unencumbered asset pool credit facilities.

This article also summarizes many of the benefits of such fund financing products and provides guidance as to when and why funds typically utilize such products.

Subscription Credit Facilities

A subscription credit facility is a credit facility characterized primarily by the collateral package securing the facility: the uncalled capital commitments of a fund’s investors, related rights and the bank account into which capital contributions are paid. Subscription credit facilities are usually revolving lines of credit that a real estate fund can draw, repay and redraw on without penalty. Subscription credit facilities could be an ideal financing option for funds in the earlier-to-middle stages of their life cycle, when the fund still has a generous pool of uncalled capital commitments to collateralize the facility. Funds use subscription credit facilities to meet a variety of financing needs and objectives, including facilitating investments and smoothing out fund operations (e.g., making fewer, scheduled capital calls). Subscription credit facilities are, and have been for about two decades, the “bread and butter” product in the fund financing space, broadly utilized by funds of nearly all stripes and sizes.

Umbrella Credit Facilities

Umbrella credit facilities (UCFs) aggregate multiple subscription credit facilities together under the same “umbrella,” allowing the same asset manager to obtain one credit facility that can provide financing to multiple funds, pursuant to one set of documents, in one transaction. UCFs can simplify subscription credit facility documentation, permit faster speed of execution and access to capital, allow for streamlined facility utilization and joinders of new future funds, lower costs and optimize pricing for the asset manager and funds. Each fund (e.g., Fund I, Fund II, etc.) is organized into its own tranche under the UCF, with separate borrowing bases and borrowing availability. Each fund is severally liable for its own obligations and puts up its own collateral as security for its obligations. By taking advantage of economies of scale, funds can often obtain better financing terms together than any one fund could alone. There are considerations that can weigh in favor of separate subscription credit facilities rather than UCFs, including lender concentration risk, but oftentimes, UCFs are more advantageous for asset managers on the whole than multiple stand-alone subscription credit facilities.

Management Fee Lines of Credit 

A management fee line of credit (management line) is typically secured by the management fees that the management company of a fund receives for managing the fund’s investments, and related rights under any management agreement that the management company entered into the with such fund. Fund managers often need capital for cash flow purposes and for general operating expenses. Since management fees are typically only paid once a quarter or less frequently, management lines can provide an important source of capital for the management company to meet its financing needs in between management fee payments.

Management lines are often a “relationship product” that a lender will offer to an existing client (e.g., for a sponsor client with a fund that already has a subscription credit facility with the lender) to grow that lender-client relationship, that the lender has comfort in underwriting, given the lender’s familiarity the underlying fund and its financial performance.

Partner Loan Programs and General Partner Lines of Credit

As funds have grown in size (sometimes up to several billion dollars each), so has the size of investors’ required capital contributions. In order to finance what may be a multimillion-dollar capital contribution, fund investors (both limited partners and general partners) often turn to debt financing for some of that capital.

Partner loan programs (partner lines) are credit lines offered to fund investors (typically high-net-worth individual investors) to finance a portion of their capital contribution to the fund. Lenders either make loans directly to the investors secured by the borrower/investor’s corresponding interest in the underlying fund, or to the fund or an affiliated entity, which on-lends the funds to its investors. Partner lines are typically secured by a security interest in the partner’s interest in the underlying fund. The lender on a partner line may also require additional credit support from the fund sponsor, e.g., in the form of a guarantee and/or require that partners pay down the partner line obligations with negotiated percentages of capital returns and distributions (other than tax distributions) from investments. Partners are treated separately and severally, e.g., if one partner-borrower defaults, that does not render the other partners in default.

Similar to partner lines, general partner lines of credit (GP lines) enable general partners to finance a portion of their capital contribution to a fund, in exchange for granting a security interest in the general partner’s interest in the underlying fund. General partner-borrowers typically repay these loans using fund-generated income (e.g., distributions received from dispositions of investments). GP lines are excellent financing options for fund general partners, particularly for general partners that are expected by limited partners to make significant capital contributions to the underlying fund, to demonstrate an alignment of interests and provide additional capital for the fund to acquire real estate assets.

Partner and GP lines are also “relationship products” that enable lenders to strengthen relationships with both the fund and the partners. These lines of credit can also benefit the fund, by facilitating additional partners investing into the fund, and benefit the partners by providing capital to finance a portion of their capital contribution obligations to the fund.

Net Asset Value Credit Facilities

A net asset value (NAV) credit facility is secured by the fund’s actual investment portfolio, the distributions from investments and an equity interest in the entity that owns those investments. Repayment of the NAV credit facility borrowings may also be guaranteed by the related fund into which investors fund capital contributions to make the investments that generate the NAV for the NAV credit facility. NAV credit facilities are ideal financing options for funds that have already deployed most of their capital (and therefore have less, if any, borrowing availability under any subscription credit facility). Funds use NAV credit facilities to obtain short-term liquidity to meet fund expenses in between distributions from investments, leverage investments, acquire additional assets including distressed real estate assets, or other needs in the mid-to-later stages of the fund life cycle.

Hybrid Credit Facilities

Hybrid credit facilities are a combination of certain aspects of subscription and NAV credit facilities and are typically secured by the collateral for both of those types of facilities. Hybrid credit facilities enable the fund to meet its financing needs and various objectives over a longer portion of its life cycle than either a subscription or NAV credit facility would alone. Toward the beginning of the fund’s life cycle, the fund can borrow against the uncalled capital commitments of its investors. As capital is drawn down and used to fund investments and those investments gain value, the fund can borrow (potentially even after the end of the fund’s investment period) against the NAV of those investments. Funds use hybrid credit facilities for many of the same reasons they use subscription credit facilities and NAV credit facilities, and enjoy the flexibility that hybrid credit facilities provide over time.

Unencumbered Asset Pool Credit Facilities

Unlike the foregoing credit facilities, unencumbered asset pool (UAP) credit facilities are typically unsecured. In UAP credit facilities, the lender will look only to a certain pool of the fund’s unencumbered real estate assets (i.e., those free of any mortgage or other security interest) and, subject to satisfaction of certain criteria as to the creditworthiness of those assets, allow the fund to borrow against their value. In lieu of granting a security interest over those real estate assets, the fund will grant a negative pledge (i.e., agree not to grant any party a security interest over the assets) and the owner of the assets (if not the fund), or a parent entity of that entity or the fund, will agree to guaranty the repayment of the UAP credit facility obligations. UAP credit facilities afford real estate funds with immense flexibility to easily add and remove assets from the pool, borrow against the value of the assets in the pool, and bridge the timing gap between asset acquisition and permanent financing (e.g., a mortgage).

Benefits of Fund Financing

The table below summarizes some of the potential benefits of the various fund financing products described above, and which products are best suited to meeting the fund’s needs or objectives at each stage in its life cycle.

Fund Finance Product	Potential Benefits	Stage(s) of Fund Life Cycle
Subscription Credit Facilities	Providing liquidity Quick access to capital Bridging time gaps in capital contributions Facilitate and leverage investments Less frequent capital calls Administrative convenience Backstop funding source Positive impact on IRR	Beginning stage Mid stage
Umbrella Credit Facilities	Flexibility Same benefits as subscription credit facilities (above) Lower costs versus multiple stand-alone subscription credit facilities Streamlined execution versus multiple stand-alone subscription credit facilities Administrative convenience versus multiple stand-alone subscription credit facilities	Beginning stage Mid stage
Management Fee Lines of Credit	Providing liquidity Quick access to capital Bridging time gaps between management fee payments Administrative convenience	Beginning stage Mid stage
Partner Loan Programs	Financing capital contributions Strengthen relationships among lenders, the fund and the partners Administrative convenience	Beginning stage Mid stage
General Partner Lines of Credit	Financing capital contributions Strengthen relationships among lenders, the fund, and the investors	Beginning stage
Net Asset Value Credit Facilities	Leverage investments Providing liquidity Quick access to capital Bridging time gaps in cash flows Funding source if capital commitments fully deployed	Mid stage End stage
Hybrid Credit Facilities	Flexibility Providing liquidity Quick access to capital Bridging time gaps in cash flows Facilitate and leverage investments Less frequent capital calls Administrative convenience Funding source if capital commitments fully deployed Positive impact on IRR	Mid stage End stage
Unencumbered Asset Pool Credit Facilities	Flexibility Providing liquidity Bridging timing gap to other financing Backstop funding source Positive impact on IRR	Beginning stage

Implications for Real Estate Funds

During these challenging economic times, many owners of distressed real estate need―now more than ever―to monetize their real estate assets. Thankfully, there is plenty of dry powder available for real estate funds to make profitable investments. Those real estate funds that are interested in taking advantage of these buying opportunities would be well-served to consult with legal counsel experienced in fund formation, asset-level real estate transactions and fund financing regarding potential ways to structure and execute transactions. Experienced counsel can help negotiate desirable terms to achieve their client’s objectives, as well as maximize tax advantages, minimize legal risks and ensure maximum efficiency from the transaction’s inception to completion.

Anastasia Kaup is a partner in the Corporate Practice Group of Duane Morris LLP. Ms. Kaup structures, negotiates and documents complex financing transactions around the globe. Ms. Kaup advises clients on a wide array of financing transactions, including all types of fund financing.

Max W. Fargotstein is a member of Duane Morris’ Banking and Finance Group. He represents both lenders and borrowers in a wide variety of debt financing transactions including fund financing, cash flow financings, asset-based financings and other commercial lending transactions. 

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