Demystifying Pari Passu in Commercial Real Estate

Pari Passu is Latin for “on equal footing”. In the world of finance it refers to a situations where two or more classes of people or transactions are managed without preference. Assets, obligations, securities, investors, and creditors can all be managed with a pari passu structure. One classic example of pari passu is the way unsecured creditors are treated in a bankruptcy. All the unsecured creditors get paid at the same time and the same fractional rate of the debt they were owed. In commercial real estate the pari passu structure is often used in commercial mortgage backed securities (CMBS) or in the waterfall structure of commercial real estate partnerships. In this article we’ll discuss pari passu in commercial real estate and clarify with some relevant examples.

Difference Between Pari Passu and Pro Rata

First of all, let’s tackle a commonly asked question about pari passu. What’s the difference between pari passu and pro rata? The terms pari passu and pro rata are often confused with each other. Pari passu is used to refer to a class. The debts or bonds are held pari passu. Pro rata technically refers to how something is distributed. In the bankruptcy example above, the unsecured debts are all pari passu. They are of the same class and will be paid on the same priority and without preference. Because the debts are pari passu, they must be paid pro rata. Distributing the money otherwise would give priority to some of the unsecured debt over others. In a practical sense there is little difference between pari passu and pro rata because when anything is held pari passu, the only way to preserve the “equal footing” is to distribute profits or losses pro rata.

Pari Passu in Waterfall Structures of Commercial Real Estate Partnerships

Pari passu is often used as part of a waterfall structure in a commercial real estate partnership. In its simplest form, some portion of the cash flow from an investment is distributed to all the pari passu investors or partners at the same time. There are usually certain targets that trigger the distribution of the cash flow. There are also usually one or more hurdles that, when cleared, allow for the managing partner to get paid an extra share of the cash flow. This is typically called the “promote”.

How does pari passu work in a waterfall structure? While waterfall structures can vary widely, it’s common to have all cash flow “pari passu” up to a preferred rate of return, say 8%. That is, up to 8% all cash flows are distributed in proportion to the investment amount (in other words, pro rata) to both the investor and the sponsor. Then, to provide the sponsor an incentive to achieve higher returns, certain tiers or return hurdles are set where (if met), the sponsor receives a larger disproportionate share of cash flow. These hurdles essentially break the pari passu structure and create increasingly disproportionate splits of the cash flow at each hurdle.

Understanding Pari Passu Structure in CMBS

Investors like pari passu structures because they allow risk to be widely allocated. Everyone is going to get paid at the same time. This reduces the risk of a project suddenly failing after some investors have been paid and leaving the remaining investors to bear the full brunt of the loss.

In CMBS a large loan on a single commercial property or project is split up into several smaller pari passu notes and those notes are packaged into different CMBS offerings. While not all the notes will be of equal size, all the pari passu notes will have the same payment priority.

These smaller notes are easier to sell as part of a CMBS because a buyer knows that a given project will only represent a small portion of the overall pool. Before the widespread adoption of pari passu structures by CMBS industry a single project might have been 20% of the pool in a single CMBS bundle. Now, usually the biggest notes are only 5% of the total pool.

Here is how a large commercial loan might be broken up in pari passu pieces and placed into a series of CMBS. The commercial loan will typically by made up of a primary note, sometimes called an A-note, and a subordinate note, sometimes called a B-note. The A-note will be split up into several different pari passu pieces and placed into different CMBS. Typically private parties hold B-notes instead of them being placed into a CMBS.

A single CMBS will be made up of several pari passu pieces of several different A-notes from many different commercial deals. The owners of the CMBS then own small pieces of the primary A-note from many different commercial loans. All of the loans that go into a CMBS are rated by a rating agency. Loans that have a low risk of default are given an “A” rating. Riskier loans are given some type of “B” rating. These ratings only relate to the risk of default and having nothing in common with the A-note and B-note designations from the original loan.

The first investors who buy the CMBS are called A-piece investors, because they are buying on the strength of the A-rated loans bundled in the CMBS. These investors will get paid first, but at a lower interest rate.

However, it is the second group of investors, the B-piece investors, which really control the CMBS market. B-piece investors have a subordinate interest to the earlier investors, but get a higher interest rate. They are buying the CMBS based on the rate of return of the B-rated loans. If a loan defaults or there is some other payment problem, all of the A-piece investors will get paid before any B-piece investor is paid. There are always buyers for the A-rated loans. But, if no one is interested in buying the B-rated loans, the CMBS system and market would collapse. CMBS are usually organized to appeal to the B-piece investors.

History of Pari Passu and CMBS

The idea of pari passu notes has been around a long time. CMBS have also been around for a long time. However, it was only after the events of September 11, 2001 that pari passu took on such a pivotal role in CMBS.

The loans for the World Trade Center were split into two different CMBS. While all bond holders were fully compensated after a period of time, the market became skittish of large commercial loans. The possibility of a single large default was suddenly seen as too big of a risk.

Pari passu solved this problem by spreading the risk of a single default across many different CMBS. No single investor or group of investors would bear a significant amount of the risk for a single loan. The use of pari passu for loans on large projects means that the holdings of a single CMBS are more diverse and therefore more stable.

Benefits of Pari Passu

The commercial real estate loan market has come to depend on pari passu. Lenders want to bundle up loans and sell them as quickly as possible to improve their cash flow and allow them to make additional loans quickly. Placing loans, or pieces of loans, into a CMBS improves the lenders capital position.

However, investors, especially the all important B-piece investors, are no longer willing to buy a CMBS where one note is a significant portion of the security. The only practical way to split up the large loans into different CMBS is to use the pari passu structure. Pari passu improves the liquidity of the entire system.

It allows investors to buy CMBS with confidence that the risk of default is low, it allows lenders to make more loans, and it allow developers to continue to pursue large commercial real estate projects. Virtually all of the growth in the CMBS market since September 11th is due in part to the pari passu structure.

Problems with Pari Passu

However, pari passu is not without its critics. Credit ratings agencies have voiced concerns for years that pari passu notes make workouts more difficult and time consuming. One of the problems during the housing meltdown and the Great Recession was that the home mortgages were split up into too many pieces and it took too long for loan workouts to take place. The longer it takes for a workout to be completed, the greater the losses end up being.

Credit rating agencies worry that the longer a note is on the market the harder it will be to track down all of the pari passu owners. Not only is it time consuming to track down all the stake holders in the case of a loan workout, but also the more stake holders the harder it is to reach a consensus. All of the delays could lead to a default that is not in anyone’s interest. Too many defaults and the CMBS industry could crash similarly to the way the home mortgage industry suffered in the Great Recession.

Pari passu notes add an extra layer of complexity to what is already a complex financial instrument. CMBS investors may feel more secure with the risk of default on a single loan more diffuse, but some critics worry the complexity increases the risk of systemic risks spreading through the system more quickly.

For now the overall default rate in the CMBS sector is well below 1%. The industry has seen the number of B-piece investors grow and shrink over the past decade and a half, but the market has always fond enough B-piece investors to keep the commercial loan to CMBS pipeline flowing.

Proposed Solutions to Pari Passu Concerns

Even though the CMBS market is largely seen as healthy and stable, there are two main things that could lower the potential risks posed by pari passu structures in CMBS. The first proposal would change who has authority to agree to a workout. The idea is that if the greatest risk is simply the large number of people that have to agree to a workout, shrink the number of people who have authority to agree to the workout.

This could be done in several ways. The B-piece investors could be given the sole authority to agree to a workout. The idea would be the first B-piece investor in the first trust where a pari passu note is placed is given the opportunity to take control of the B-note. If the first B-piece investor declined, the next B-piece investor would have the same opportunity. However, at least one B-piece investor would have to take control of the B-note and the authority to agree to a workout.

Another way to limit the risk of pari passu is to limit the transferability of shares. This would make it easier to know who needs to be consulted in the event of a loan workout. It would also mean that some later buyers would only get limited shares. They would not get workout authority with their shares. This idea is based on the way the syndicated loan structure has evolved.

Even with its critics, pari passu will remain integral to the CMBS industry for the foreseeable future. Investors are enthusiastic about it and large commercial real estate lenders see it an indispensable to keeping their business running smoothly.

Understanding Ingress and Egress in Real Estate

When property is purchased, buyers often make several assumptions. Buyers assume they will be able to use the property. Buyers also assume they can enter and exit the property. But, the rights to enter and exit the property may be separate from the ownership of the property. Ingress is defined as the right to enter the property and egress is defined as the right to exit the property. Others may also need or have a right to ingress or egress on your property. If proper care is not taken to understand and secure these rights, it could spell disaster for a commercial real estate transaction.

Ingress, Egress and Easements

The rights of ingress and egress are often secured by easements. An easement is a legal right to a limited use of another’s property. You may need an access easement to cross over someone else’s property to enter or exit your own property. You may need an easement on a private road that will allow you access to the property and ensure you can get to the main roads in the area. If there is a shared driveway, you may need an easement to allow you to use it.

Easements should be officially recorded, just as you would officially record the title to a property. Usually, you have the ability to sell an easement along with the deed to the property.

Others may have an easement on your property that gives them a right of ingress and egress as well. One typical example is the easement utility companies have on most properties. This easement allows them to enter a property to check meters and to repair or replace equipment essential to the working of the line. It is often not necessary for you to grant the easement to the utility company because in most jurisdictions the utility easement exists as a matter of law.

Special Issues of Landlocked Property

Some parcels of property are landlocked. They have no public access point. Landlocked parcels can be found anywhere. In a rural area where a large landowner is subdividing his or her land into smaller parcels, some of the parcels may be landlocked. In urban and suburban settings it is not uncommon to find a small store or other commercial enterprise surrounded by other businesses. The small store may be landlocked by its neighbors.

If a landlocked property does not already have an easement over adjacent property, you will need to secure an easement, or some other right of ingress and egress before buying the property. Otherwise you risk committing a civil trespassing offence every time you enter or leave your own property.

Landlocked commercial property in many jurisdictions does not come with an automatic access easement over neighboring properties. Lenders will require proof of the right of ingress and egress as part of the conditions of issuing a loan for the purchase of commercial real estate.

Neighboring landowners can sell an access easement. Sometimes neighboring landowners will want to limit the access an easement gives the landlocked property owner. However, easements are usually not a good way to strictly limit access. If limits are needed instead of giving an easement, the neighboring property owner should consider a different type of agreement.

How to Secure Ingress and Egress Without an Easement

Because under the law easements can both give to broad a right of access from the point of view of a neighbor and too narrow a right from the point of view of the easement holder, often other types of arrangements work better for securing the rights of ingress and egress.

Owners of landlocked parcels, or other difficult to access parcels, may wish for ingress and egress rights to be part of the deed, instead of as a separate easement. This provides several advantages to the owner of the limited-access property. It makes the process of documenting the rights easier. If the owner goes to sell the property later, having the rights explicitly in the deed will put the future buyer at ease. Having rights of ingress and egress spelled out, as part of the deed to property, is easiest to achieve when buying the access-limited parcel from the landowner who also owns the neighboring property you will have to cross to get to your property.

Sometimes a property owner will want a land use agreement. A land use agreement is a contract that spells out specific duties and responsibilities between the two sides. Land use agreements should be recorded with the county, just as an easement is recorded. A land use agreement gives the parties great flexibility in determining just how much access will be granted. A land use agreement can limit the tonnage of trucks that can cross the neighboring property, or whatever limits the two sides agree to. A land use agreement will also usually explicitly state what the limited-access property owner must pay for the upkeep of any roads.

Ingress, Egress, and Due Diligence

Verifying the ingress and egress rights is an essential part of the due diligence process when purchasing property. Even when access seems obvious, the source of the ingress and egress rights needs to be tracked down. Not only may a lender require such assurances, but it also helps avoid later legal trouble.

Part of the title search process should include documenting the ingress and egress rights. Such rights should be on the deed, in the form of a recorded easement, or land use agreement. If a title search cannot find a recorded document establishing the ingress and egress rights, the seller will need to demonstrate that he or she has those rights and then explicitly convey them to the buyer as part of the transaction.

These steps may be needed, even if the property is not landlocked. If the public access point is remote to the part of the property that is or is going to be developed, or certain weather conditions make the public access point impassable certain seasons, it is prudent to have easement or a land use agreement with a neighbor that provides more reliable and practical access to the property.


The rights of ingress and egress are essential to the full use of any property. In this article we talked about ingress, egress, and easements in depth, as well as alternatives to easements. Ensuring that you understand both what rights you have with respect to your neighbor’s property as well as what rights others have with respect to your property is a key part of the due diligence process.

How to Use The Modified Internal Rate of Return (MIRR)

The Modified Internal Rate of Return, often just called the MIRR, is a powerful and frequently used investment performance indicator. Yet, it’s commonly misunderstood by many finance and commercial real estate professionals. In this post we’ll take a deep dive into the concept of the MIRR. We’ll define the MIRR, look at the logic and intuition behind the MIRR, dispel some common mistakes and misconceptions, and finally we’ll tie it all together with a relevant example.

What is MIRR?

First of all, what is the definition of MIRR? The Modified Internal Rate of Return (MIRR) is a variation of the traditional Internal Rate of Return (IRR) calculation in that it computes IRR with explicit reinvestment rate and finance rate assumptions. The MIRR accounts for the reinvestment of any positive interim cash flows by using a reinvestment rate, and it also accounts for any negative cash flows by using a finance rate (also known as a safe rate).

The reason why these two rates are used is because it allows for any positive cash flows thrown off by an investment over the holding period to be reinvested at the “reinvestment rate”. It also allows any negative cash flows to be discounted back to the present time at the “finance rate” to determine how much needs to be set aside today in order to fund the future cash outflows.

By using this approach, the MIRR boils a set of cash flows down to just two numbers: 1) a single initial investment amount at the present time and 2) a total accumulated capital amount at the end of the holding period. Then, a single rate of return can be calculated using only these two numbers, which results in what’s known as the MIRR.

MIRR Example

Let’s take an example of the modified internal rate of return to see how this works. Suppose we have the following set of cash flows:

MIRR Example Cash Flows

We invest $100,000 today and in return we receive $18,000 per year for 5 years, plus at the end of year 5 we sell the asset and get back $100,000. If we use the traditional Internal Rate of Return (IRR) calculation, we get an IRR of 18%.

As you may recall, one of the problems with the traditional IRR calculation is that it doesn’t account for the reinvestment of interim cash flows. So, how can we use the Modified Internal Rate of Return to eliminate this problem?

First, let’s explicitly define a reinvestment rate for all of the $18,000 interim cash flows. In order to account for the yield we can earn on these interim cash flows, let’s assume we can reinvest them at a rate of 10%. Note that this rate is lower than the above calculated IRR. This could be for a variety of reasons. For example, it could be the case that we can’t find any other investments that yield higher than 10%.

MIRR Reinvestment Rate

As shown above, we simply take each of our interim cash flows of $18,000 and then compound them forward at a rate of 10% to the end of year 5. When we add up all of our cash flows at the end of year 5 we get a total of $209,892. By doing this we have transformed our initial set of cash flows into a different time value of money problem, which takes into account the yield we earn on interim cash flows that are reinvested elsewhere. Now we can simply take our new set of cash flows and solve for the IRR, which in this case is actually the MIRR since it’s based on our modified set of cash flows.


As you can see, the MIRR when using a 10% reinvestment rate is 15.98%. This is less than the 18% IRR we initially calculated above. Intuitively, it’s lower than our original IRR because we are reinvesting the interim cash flows at a rate lower than 18%. Also take note again that the MIRR calculation here is simply the IRR calculation. The only difference is that now we’ve transformed our initial set of cash flows into a new, modified, set of cash flows. That means that when we now calculate the IRR it’s a modified IRR.

MIRR Example With Negative Cash Flows

Using the reinvestment rate on positive interim cash flows like we did above is how MIRR is commonly used, but sometimes there is more than one negative cash outflow during the holding period. Consider the following set of cash flows:

modified internal rate of return cash flows

We have the same initial $100,000 upfront investment, but now we also have to come out of pocket $50,000 in year 2 for a capital expenditure. However, once this improvement is realized, our cash flows increases from $18,000 to $25,000 and now we can also sell the property at the end of year 5 for a higher price. This results in a higher IRR of 19.33%, but what does it do to our MIRR?

Let’s first tackle the positive interim cash flows by compounding them forward to the end of year 5.

Modified Internal Rate of Return Reinvestment Rate

This is the same process we followed in our first MIRR example, but now we simply ignore the negative cash outflow in year 2. This leaves us with a -$100,000 initial investment, a -$50,000 cash outflow in year 2, and a $309,104 cash inflow at the end of year 5. Next, let’s discount our -$50,000 outflow back to the present time at our finance rate or safe rate.

MIRR finance rate safe rate

This simply tells us that if we want to have $50,000 available to spend in 2 years, then we need to set aside $45,351 today in an account earning 5% annually. So, now we’ve transformed our original set of cash flows into a new modified set of cash flows that has just two figures: a $145,351 initial investment and a $309,104 accumulated capital amount at the end of the holding period.

MIRR calculation 2

Now we can simply calculate an IRR on the above modified set of cash flows to get a Modified Internal Rate of Return of 16.29%. This modified internal rate of return now accounts for the funds we need to set aside today at a safe rate in order to fund future capital outlays. It also accounts for the reinvestment of all interim cash flows at our expected reinvestment rate.

How MIRR Solves the Multiple IRR Problem

You may recall that one of the problems with the traditional IRR calculation is that there are as many solutions to IRR as there are sign changes in a set of cash flows. Let’s take a look at an example set of cash flows:

Multiple IRR Example

When you run an IRR calculation on the above set of cash flows you indeed get multiple solutions. For the above set of cash flows we get 3 different IRR solutions: 0%, 100%, and 200%. So, which one is correct? The answer is that all of them are correct! Why is this? The short answer is that the IRR formula is not a linear equation but instead it’s a polynomial which can generate multiple solutions. This is also the reason why the IRR function in Excel asks for a “guess” as an input. This is used to help Excel determine which solution is correct in case there are multiple solutions.

The good news is that the MIRR eliminates this well-known problem with IRR. To see how, let’s run the MIRR on the above set of cash flows using the same procedure we followed above. We’ll skip the interim steps of discounting negative cash flows at the safe rate and compounding interim positive cash flows at the reinvestment rate. However, this process is exactly the same as we followed above and it leaves us with the following modified set of cash flows:

multiple IRR MIRR solution

And now when we calculate an IRR on this modified set of cash flows we get 2.30%. Using the modified internal rate of return eliminates the multiple IRR problem because we are explicitly defining our safe rate and reinvestment rate. This boils the set of cash flows down to just two figures, resulting in a single MIRR figure.


In this article we discussed the logic and intuition behind the modified internal rate of return, or simply the MIRR. The MIRR is a powerful investment metric that is gaining in popularity since it eliminates the problems with the traditional IRR calculation and also provides a more realistic measure of return. In this article we broke down the MIRR calculation step by step to make understanding the mechanics of MIRR easy to understand.

The Role of Title Insurance in Commercial Real Estate Transactions

Title insurance is one of the key pieces of any commercial real estate transaction. Without it, buyers and sellers would most likely find the risks of buying and selling property to be too high. Title insurance has been around in one form or another in the United States since 1874. The stronger your understanding of what title insurance is and its role in commercial real estate transactions, the better prepared you are for negotiating great deals and protecting your assets.

What is Title Insurance?

Title insurance is insurance that protects the buyer from any problems with the chain of title to a piece of real estate. Title insurance is used in both residential and commercial real estate transactions. Because the amounts of money are bigger, financial transactions are more intricate, and title is often more complicated, title insurance plays a vital role in the buying and selling of commercial real estate.

What Title Insurance Protects Against

Title is the right to ownership of a parcel of real estate. Deeds convey title between buyers and sellers. But, not all deeds convey full ownership of the property and real estate can be subject to liens or other encumbrances that limit the rights of ownership.

A buyer in a real estate transaction is buying insurance that the title to the property they are seeking to acquire is just as the seller promised it is. If a seller claimed to convey full and clean title to a buyer, but later a third party claimed that they actually had the rights to the property and not the seller, the title insurance will protect the buyer.

Every policy is slightly different, but typically the title insurance will cover the legal fees over the title fight and in the event that the third party prevails and is awarded the property the buyer paid for, reimbursement to the buyer.

The Role of the Title Search

Before a title insurance company will issue a policy, they will conduct a title search. This involves examining all of the recorded property transfers for the property in question. This research is called a title search.

The title search does not just trace ownership, but also looks at liens and other encumbrances, such as easements, that have been made against the property. During the title search every effort is made to ensure that the results of each lien and transfer are known.

At the end of the title search a preliminary title report is issued for the buyer and seller to examine before the title insurance policy is issued.

Different Types of Policies and Endorsements

Title insurance companies typically offer two different types of policies. There are loan policies and owner’s policies. Loan title insurance policies are designed to protect the investment of the bank or other lender should any problem with the title later surface. An owner’s title insurance policy is designed to protect the buyer or owner of the property from the future discovery of problems with the title to the property.

Title companies also offer a variety of endorsements for title insurance polices that protect against more than just title issues. These endorsements may cover things such as boundary mistakes, zoning conflicts, and environmental issues. The cost of the endorsements varies considerably depending on the risk factors and the value of the property.

Getting Title Insurance

There are numerous title insurance companies all over the country. Because title insurance agents also often act as the escrow agent in commercial real estate transactions, the buyer and seller must agree on which title company to use. The title insurance company is brought into the process early on, before closing. The title insurance process begins at the end of the due diligence phase and lasts through the completion of the sale.

The American Land Title Association (ATLA) governs the industry standards for the issuance of commercial real estate title insurance.

How is Title Insurance Used in Commercial Real Estate?

While title insurance in residential real estate is often seen as a mere formality, title insurance is an integral part of both the due diligence phase and the closing process in commercial real estate deals. Because the stakes are so high in commercial real estate, all of the parties from the buyer and the seller to the lender or lenders have a vested interest in making sure the title insurance issuance goes smoothly.

Who Pays for Title Insurance and Who Owns the Policy?

If a lender is involved in the transaction, the buyer will almost always pay for the loan title insurance policy. The cost of the policy is often rolled into the cost of the loan. If there are multiple lenders, each lender will require their own policy.

The buyers will also want an owner’s title insurance policy. Sometimes the seller will pay for this policy as part of the closing costs. However, as a practical matter, the buyer is the one ultimately baring the cost of the owner’s title insurance policy, as the seller will just add the cost into the purchase price.

The party who benefits from a title insurance policy will not necessarily be the same as the party who pays for the policy. While the buyer may be paying for the loan policies, if something goes wrong with the property, it will be the lenders that benefit from the policy, not the buyer.

The issue of who benefits from the policy is why buyers should have a separate owner’s policy. Even if the seller is paying for the policy, the buyer will benefit from the policy should there be any trouble with the title at a later date.

The Title Insurance Agent

While the title insurance agent is most irrelevant in residential real estate deals, they often play an integral part in commercial real estate deals. The title insurance agent will make sure the title search is conducted in a timely manner, communicate with the buyer and seller about the status of the title search, and the issuance of the preliminary report. Most of the time the title agent will also act as an escrow agent for little or no extra charge. He or she helps keep the closing process streamlined.

What Happens When Something Goes Wrong With the Title?

While most insurance products that you buy are to protect you against some future problem, title insurance protects you against something that may have already happened, but that you aren’t aware of yet.

If someone later comes forward to challenge your property rights or title to the property you will have to make a claim with the title insurance company. Depending on what your policy covers and what endorsements you purchased, the title insurance company will usually investigate the challenge and defend you against it.

Very early in the process a commercial real estate lawyer will be brought into help evaluate the claim and try bringing a swift end to any challenges. However, like all legal matters, disputes over title to a property can drag on for several years.

The Preliminary Title Report

One of the most important documents in the entire commercial real estate transaction is the preliminary title report. After the title search is completed, the title insurance company will issue a preliminary title report that explains its findings. This report will show any liens or other encumbrances currently made against the title to the property. It will also make a statement as to the title the seller has to the property. If any property rights have been previously sold, such as water or mineral rights, the title report will indicate when the transfers were made and to whom.

What Does the Report Mean to the Seller?

Once the preliminary report is issued the seller has a chance to review the report and challenge any of the findings. If there are any errors, the seller can demand that the errors be corrected and a new preliminary report issued.

If the report finds that the seller does not have the clear title that they thought they had, the seller can do their own investigation or go back to the title insurance policy they were issued when they purchased the property.

There is a small window of time for the seller to make any objections to the preliminary title report before it is made final.

What Does the Report Mean to the Buyer

The buyer needs to carefully review the report to ensure it substantiates the seller’s claims as to title and property rights. The policy will be based on the preliminary report. If there is anything the buyer is uncomfortable with, the preliminary report represents their last chance to pull out of the deal without severe financial consequences.

The buyer can also make objections to the report if there are inaccuracies.

Accepting the Preliminary Report

Once the objections of both sides have been dealt with, the parties will accept the report and it will be made final. The final report will become part of the title insurance policy that is issued to the lenders and the buyer.

After the report is accepted and the insurance issued, the rest of the transaction will quickly close. The title insurance agent, acting as escrow agent, will transfer the funds to the seller and the executed title documents to the buyer.


Title insurance makes commercial real estate transactions possible and keeps the closing process running smoothly. Without title insurance it would be impossible to get lenders to risk large amounts of capital on complicated transactions and buyers would be much more reluctant to buy from strangers. In this article we covered the role of title insurance in commercial real estate transactions, and along the way we outlined how it works, why it’s important, and what could go wrong.

Definitive Guide to the Commercial Real Estate Closing Process

When it’s time to on a commercial real estate transaction the process can seem overwhelming. This definitive guide will walk you through every step in the commercial real estate closing process. You will see where the commercial process is similar to the residential process, and where things are different. You will also discover the places you need to be cautious and where your due diligence efforts are most important. Commercial real estate has fewer protections for buyers, but also gives parties more room to be creative with deal making.

There are four major steps to closing a commercial real estate deal. Some of these steps are ongoing and others overlap. Every transaction will go through escrow, signing authority verification, due diligence, and signing and processing title and closing documents.


Just like when you purchase a home, escrow is an important part of the commercial real estate closing process. In escrow a neutral third party will hold funds in an account until either all of the requirements of the escrow agreement have been met, or until one party pulls out of the deal in accordance with the terms of the escrow agreement. Escrow is designed to solve the problem of trust between two parties. Nobody gets paid or receives title to the property until both parties have had their agreed upon conditions met.

Escrow in a Commercial Real Estate Transaction

Most private home sales have an informal escrow process. Because commercial sales often involve larger sums of money and are more complex, escrow in this setting is formal and tightly controlled. Capital for a commercial transaction will often come from many different sources. Additionally, because there is less regulation of commercial real estate deals the parties must do more due diligence to protect their investments. The paperwork involved is highly customized and more extensive than the form documents used when buying a home.

The parties will often have negotiated an escrow agreement that the escrow agent must verify has been satisfied before releasing any funds.

Title Agents as Escrow Agents

While there is no legal requirement for who the buyer and seller must chose to serve as the escrow agent, most of the time the title agent will act as escrow agent. Title agents are usually already familiar with the details of the transaction and have no financial interest in the success or failure of the deal as their fee is for services rendered regardless of the outcome of the deal. Title agents also have the expertise to create the customized closing documents vital to most commercial real estate transactions.

Escrow Agreement

Before money can be transferred to the escrow agent, the parties have to come to some agreement as to what the escrow agent’s duties are and what will satisfy escrow and allow the funds to be released to the seller of the property.

Unlike residential sales, the escrow agreement in commercial real estate closings is unique for each deal. However, there are several common escrow agreement provisions such as:

  • Clause appointing the title agent to act as escrow agent and to waive any fee acting as an escrow agent
  • Clause ordering escrow agent not to commingle funds sent by the buyer with any other monies.
  • Statement of when written instructions from buyer and seller need to be received before funds can be released.

Typically escrow agents won’t have any responsibility for verification of any part of the deal other than only releasing funds when instructed from both the buyer and the seller. Instructions to release the funds are almost always required to be in writing.

Dealing With Legal Entities and Authority

Instead of a contract between two people, a commercial real estate deal involves one or more contracts between two or more legal entities. Because these deals are expensive all parties want to limit their liability and often create legal entities for the sole purpose of owning a piece of commercial real estate. For every entity such as a corporation, LLC, or LLP involved, additional steps must be taken to verify their fitness and ability to conduct the transaction.

Why Legal Entities Are Used

One feature of American law is that investors in a corporation are shielded from loss or liability for the actions of the corporation up the amount of their investment. In other words, if a corporation gets sued the investors may lose their investment in the corporation, but their personal assets will not on the line. This same protection also extends to LLC’s and LLP’s in most states.

Investors know that commercial real estate can come with large risks. Legal entities are used to protect individual investors from liability both as sellers and buyers.

Even existing legal entities buying additional property will sometimes create a new legal entity or subsidiary, to isolate the risk of acquiring or selling a piece of property.

In many states there are tax advantages to owning commercial real estate in a legal entity.

Signing Authority Verification

A corporation or other legal entity may be the actual party to a transaction, but a human being will still need to sign and execute documents of the behalf of the entity. This creates an extra layer of paperwork in the commercial real estate closing process.

Both sides will want proof that the person signing on the dotted line has the authority to do so. This is called signing authority. Proof of signing authority can be in the form of a corporate charter that expressly gives the individual such authority, letters of authorization from the president, CEO, or board of directors of the entity, or a resolution from the board of directors or equity partners.

Until documents demonstrating signing authority have been received, a party will not allow the money in escrow to be disbursed. The seller wants to make sure the buyer has the legal authority to commit to the transaction and the buyer wants to make sure the seller is legally authorized to dispose of the asset.

Making Signing Authority Easy

Before proceeding too deeply into a commercial real estate deal, you should make sure the proof of signing authority will not be an issue for your legal entity. Here are a few ways to setup authority before entering into a transaction:

  • Designate someone by name or title in the corporate charter to have the authority to enter commercial real estate transactions.
  • Get authorization from the board of directors to execute the purchase or sale of a specific piece of property
  • Have a signed and notarized letter from the other partners authorizing the transaction and designating someone to have signing authority on behalf of the entity.

By making sure the authority issue is resolved before the closing process you will save valuable time.

Lack of RESPA and Due Diligence

The Real Estate Settlement Procedures Act (RESPA) is the main federal law that governs residential home sales. This law requires sellers to make several guarantees and warranties to buyers about the condition of the property and the absence of a variety of environmental defects. RESPA also governs the form of closing documents that can be used. The purpose of the law is to protect homebuyers from being deceived and buying a house that is dangerous or uninhabitable. RESPA does not apply to commercial real estate transactions.

What the Lack of RESPA Means to Commercial Real Estate Closings

The lack of RESPA affects commercial real estate closings in two major ways. One, it means that buyers and sellers must perform detailed due diligence on the property and the other parties to the transaction, which can delay the closing of the deal. Two, the lack of RESPA frees the parties to be more creative in structuring the deal and in they types of closing documents they choose to use.

During a commercial transaction the buyer is constantly trying to preserve the right to withdraw from the deal as long as possible and the seller is trying to limit the right of the buyer to withdraw. Buyers are looking to add contingencies and sellers are looking to close all contingencies long before escrow and the closing process. The buyer is also trying to keep the seller on the hook for any problems that become apparent after the sale for as long as possible while the buyer wants to terminate its liability as close to the closing date as possible. These tensions are reflected in the due diligence process and the form of the closing documents.

Due Diligence

Because there are fewer state and federal protections for buyers and sellers in a commercial real estate transaction, the due diligence process is much more extensive.

Buyers will want to make sure the following areas are in order:

  • The contract of sale has been properly executed
  • Receipt of most recent title insurance policy
  • Updated survey report
  • Receipt of true copies of all leases
  • Review of new environmental report
  • Termination notice conditions and due diligence deadline
  • Delivery of all tenant estoppels
  • Review of the seller’s books and records
  • Confirmation of zoning compliance
  • Search for any outstanding tax cases or liens

Sellers will want to make sure the following are in order:

  • The contract for sale has been properly executed
  • Buyer has delivered down payment to escrow agent
  • The escrow agent has deposited the money in a segregated interest bearing account
  • Filed a response to any objections to the title and survey report
  • Execution of assignment and assumption of leases by buyer

Every transaction is different and certain deals may require even more steps in the due diligence process than those discussed above.

No RESPA and Commercial Real Estate Closing Documents

In addition to the due diligence procedures discussed above, both parties will want to make sure all of the closing documents are reviewed for accuracy and properly executed on time.

In residential real estate transactions RESPA requires use of a specific form for all closing documents. In the commercial real estate closing process the parties are free from the RESPA requirements and can draft the closing documents as they see fit. This will often cause some back and forth as the parties negotiate over the exact form the documents will take, but it also gives the parties more flexibility to get a deal done that both sides can live with.

Title and Closing Documents

Before a deal can be completed the buyer and seller must both agree to accept a title report and execute a series of closing documents. The closing documents may include assignments and assumption of leases, deeds, environmental reports and assignments of liability, zoning disclosures and warranties, and anything else the parties decide is necessary to close the deal.

Commercial Title Issues

Earlier in the process of negotiating the transaction a title company will be hired to issue a preliminary report of the state of the title to the property. Commercial real estate titles are often much more complicated than residential titles. There are any number of liens and encumbrances such as easements that have to be accounted for. Often the seller may no longer hold some of the below ground rights such as mineral or water rights.

Once the preliminary report has been issued the buyer must carefully review it and file any objections or concerns to the report under a deadline. If the buyer has any objections the seller often has a limited period of time to respond to the objections of the buyer can walk away from the transaction.

Once all of the issues with the title have been settled the title company will issue the final report. Both the buyer and the seller will then review this report for errors or concerns and any issues will have to be resolved before the transaction can move forward.

Zoning/Building Jackets

Buyers will want reassurances that the property is correctly zoned for its current use and for the buyer’s intended use. As part of the closing documents the parties will want a report that proves a zoning and building jacket search have been conducted and that there are no known zoning issues. Depending on the jurisdiction, this report may include letters from the local municipalities, endorsements to the title of the property, or a detailed report from the title company.

Environmental Reports

Because liability for environmental problems can be so severe, the parties will usually require a separate report and document to deal with the current understanding of environmental issues such as a known wetland or known ground or water pollution. The buyer will want some statement from the seller stating the property is otherwise free from issues and the seller will want to try and avoid making such a statement. A document detailing the final agreement of the parties as to both the nature of any environmental issues and future liability for later discovered issues will be part of most commercial real estate closings.


Like in residential transactions, part of the closing documents will be some form of deed, typically a quitclaim deed, but sometimes a special warranty deed is used. This document once recorded officially transfers ownership of the property from buyer to seller. A title affidavit will also accompany the executed deed.

Federal laws such as the Patriot Act, also require that a non-foreign entity affidavit be executed with the deed.

The title and the terms of the deed will have been reviewed and discussed long before the formal closing documents are executed.

Assignment and Assumption of Leases

Unlike in a residential transaction, a commercial real estate closing will include an assignment and assumption of leases. This document explains that the benefits of any lease transfers from the seller to the buyer. It also transfers future liability for breaches of the lease from seller to buyer and details responsibility for lease breaches prior to the sale. This document also notifies tenants of the change in ownership.


The commercial real estate closing process is more involved and complicated than the residential real estate closing process. Because there is less federal regulation of the process, the parties have greater freedom to structure the deal and the closing documents, but both sides also must exert greater due diligence. Because of the large amounts of money involved and a variety of sources of capital escrow is more formal and both sides of the transaction are usually legal entities. The closing process takes longer in commercial real estate deals, but there are more tools to resolve issues than in residential purchases. This article gave a broad overview of the commercial real estate closing process, but as always, it’s best to consult a competent real estate attorney to discuss your particular situation.

How Green Bonds Work in Real Estate

While the movement to make commercial real estate more sustainable is already several decades old, a new tool has been steadily taking hold in the marketplace that makes financing costly environmental upgrades attractive to investors and issuers. Green bonds have grown from just $12 billion in 2013 to over $36 billion in 2014. This year looks to see green bonds continue to sell at the 2014 level. Investors and issuers have both found a lot to love in green bonds.

What Makes a Bond “Green”?

Green bonds refer to debt financing instruments that are issued for the purpose of creating new developments or upgrading existing infrastructure in a way that is environmentally sustainable. Traditionally the biggest issuers of green bonds have been the World Bank and various national governments and municipalities. However, increasing private corporations are issuing green bonds to fund the renovation of buildings to make them more energy efficient and other environmental upgrades.

There are not any internationally accepted standards for what makes a bond “green”, but lenders often tie the issuance to specific and verifiable conditions that the borrowers must follow to qualify. With the rapid growth of this sector further regulation and an international consensus about green bond standards seem likely in the near future.

How Are Green Bonds Being Used?

In the United States one type of green bond that has been especially attractive are tax free bonds issued by federally qualified organizations or municipalities to clean up brownfield sites. Brownfield sites are specific areas that are underdeveloped or are in a state of urban decay. Often these areas have low levels of industrial pollutions as well.

Under the federal Qualified Green Building and Sustainable Design Project Bonds program, developments can qualify for tax free bond status if it meets three conditions:

  • The development project will receive at least $5 million dollars from a municipality or state
  • 75% of the development buildings register to receive LEED Certification
  • The building or buildings are at least 2 acres in size

Beyond this federal program, cities, counties, and private lenders are creating more green bond programs. Investors seem eager to invest in these instruments because of their relatively good yields and the social dividends they produce.

Many organizations are also looking at securing green bonds as a way to finance much needed energy efficiency upgrades to HVAC systems and to lower occupancy costs by improving the overall energy footprint of their buildings.

The powerful GRESB recently released a set of comprehensive guidelines for green bonds for the real estate industry. Among the recommendations is that lenders tie the bonds to the borrowers securing energy efficiency certification from a third party such as Green Star, LEED, or BREEAM.

Currently most real estate green bonds are used for projects that fund construction of green buildings, energy efficiency upgrades, on site renewable energy generation such as solar panels, sustainable waste management upgrades, and sustainable water management.

Tax and Interest Rate Advantages of Green Bonds

Green bonds may be aimed at a social good, but unlike many attempts at using market mechanics to make social gains, green bonds do not require any type of good conscience premium. The returns on green bonds are in line with other conventional bonds. This is goods news for supporters who see green bonds as a chance to reward private investment in environmentally friendly development.

Because many green bonds are issued by government entities many are tax free bonds. Investors looking for safe investments with reliable cash flow and tax savings are drawn to green bonds.

Some private borrowers are drawn to green bonds because they give companies a certain “green” cache and allow them to get dedicated funding for projects that make sense to the bottom line like installing solar panels or upgrading the energy efficiency of a building by improving ventilation or electricity conservation.

Downsides of Green Bonds

But, not everyone sees green bonds as a great social win. Instead of growing in the first half of 2015, demand for green bonds remained steady. This disappointing trend is particularly stark after the huge spike in the sector the previous year. One of the main drags on the industry is a lack of standards.

Any project could be labeled “green” and marketed to potential buyers under that premise. The lack of standards has some investors who should be excited about investing in green bonds worried.

The lack of clear standards has also affected borrowers. Many lenders want to make sure a project is objectively “green” and require many levels of verification as a requirement to issue a green bond. Borrowers are wary of the extra time and costs required. Some worry that the savings they hope to gain will be postponed a year or two further down the road because of the costs of getting certifications and meeting the lender’s verification requirements.

Critics question whether green bonds are more than a public relations move for companies that could get the same types of projects funded under more conventional terms. They note that unless a code of green bond standards emerges, the industry really is dependent upon the good feelings investors get for putting their money into green projects. The worry is that the good feeling of investors is not a sustainable trend.

The Future of Green Bonds

Green bonds have rocketed out of obscurity just a few years ago to become a major force in the bond market. While there is currently a surplus of solid debt options for investors, green bonds seem unlikely to recede back into obscurity.

The public relations benefits of green bonds look to continue to be significant, and many aging buildings continue to need major environmental upgrades to remain profitable and attractive to future tenants and buyers. The single biggest obstacle for the wider acceptance of green bonds is the lack of standards.

However, with groups like the GRESB becoming more involved in pushing common standards, an industry standard for green bonds seems likely to evolve in the coming years. It also seems highly unlikely that the SEC will let a segment as large as green bonds continue to exist without tighter standards to protect investors from the unscrupulous issuers of standard bonds in green bonds clothing.

For now, whether you are an investor, an issuer, or a borrower, there is a lot of money at stake in green bonds, and the sector isn’t going away. Through solid due diligence all sides of a green bond transaction can still get a great deal and profit handsomely, while also making the planet a cleaner place to be.

Mezzanine Financing Basics and The Intercreditor Agreement

Financing short falls within the commercial real estate market have become a common occurrence. The great recession has made traditional lenders more sensitive to risk, frequently leaving developers and project investors with large financing shortfalls. Sponsors can seek out family and friends financing or a larger joint venture (JV) equity injection, but sometimes this gap may be too large to overcome through traditional methods of financing. Mezzanine financing is designed to fill this gap.  In this article we’ll give you a broad overview of mezzanine financing, common mezzanine loan structures, and we’ll also cover the importance of an intercreditor agreement.

What is Mezzanine Financing?

First of all, what exactly is a mezzanine (mezz) loan? Mezzanine financing is a unique financing instrument which doesn’t cleanly fall into a specific category of the capital markets financing quadrant. It’s a general term that refers to any financing vehicle (debt or equity but typically issued by private sector participants) that bridges the gap between senior debt and sponsor equity. It can be structured as preferred equity or as debt.

mezzanine financing

In general, traditional mezzanine financiers are not entitled to receive returns on their investments until senior debt holders are fully compensated.   Because of its subordinate position, the mezzanine loan assumes a higher risk profile than senior debt but retains a less risky position than preferred equity. With this understanding, Mezzanine debt investors seek returns between senior debt lenders and preferred equity investors but this will largely depend on how the deal is structured.

mezzanine financing capital stack

Basic Mezzanine Financing Structure

Mezzanine deals that are structured as debt instruments usually have one of the following forms of collateral:

  • Second deed of trust – This is the most desirable form of collateral to the mezzanine lender because it provides the most tangible form of security. It allows the mezzanine lender to foreclose on the property if the borrower defaults on payments. This type of security is rare since the first mortgage lender typically does not allow this type of arrangement.
  • Assignment of partnership interest – This is the most common form of debt security in the mezzanine finance universe. An assignment of partnership interest gives the mezzanine investor the option to take the borrower’s ownership interest in the property in the event of default. Effectively the mezzanine lender becomes the equity owner and assumes the obligations to the first mortgage lender. This type of arrangement is supported by an intercreditor agreement with first mortgage lender. This intercreditor agreement is discussed in detail below.
  • Cash flow note – This gives the mezzanine lender an assignment of all cash flow from the property in exchange for the mezzanine loan proceeds as well as a percentage of the proceeds from sale of the property. The cash flow note is not a recorded instrument and typically does not need an intercreditor agreement. This is also sometimes called a soft second.

Deals structured as equity have a different set of characteristics. Equity deals are joint ventures between the equity/owner and the mezzanine lender that are guided by the partnership agreements. Major provisions in the partnership agreements cover decision-making authority and specify decisions that require approval from the mezzanine partner. In the event of default with respect to the mezzanine loan, the mezzanine provider may foreclose on the pledged equity interests, not on the underlining property itself, and become the owner of the equity interests in the property-owning entity. Therefore, the owner/sponsor has significantly less control over the project and may lose all control if the property does not perform as expected. These rules are typically enforced by Uniform Commercial Code (UCC) article 9.

With mezzanine financing, owners sacrifice flexibility, control, and upside potential, and will ultimately pay a higher price for the capital. However, in return, owners won’t be required to contribute as much cash and they also gain a partner who might step in to help if the property starts to falter. What actually determines what a mezzanine provider will and will not do in a default scenario is dictated by the intercreditor agreement, a key link between the senior debt lender and the mezzanine financing provider.

Mezzanine Financing and The Intercreditor Agreement

The intercreditor agreement is negotiated by the first mortgage lender and the mezzanine provider. The purpose of the intercreditor agreement is to outline communication channels and provide guidance between the first mortgage lender and the mezzanine investor. More importantly, the agreement gives certain rights to the mezzanine financing provider in the event of a borrower default.

Many first mortgage lenders, mainly conduit lenders, refuse to negotiate intercreditor agreements, especially if the loan has already closed. In fact, conduit loan documentation routinely prohibits selling or transferring more than 49% equity ownership in the property to a partner. Some non-conduit lenders take the attitude that their interests are already covered in the agreement with the borrower and there is no need to complicate matters by bringing in an additional financial partner with different and potentially conflicting objectives.

Other lenders see value in what mezzanine financing providers can bring to the deal. The additional capital can allow the borrowers to purchase the desired property, pay leasing commissions, tenant improvements and pursue other value-adding strategies. In this case, and especially when the mezzanine financing provider is an experienced real estate investor, the first mortgage lender will often welcome their participation. The depth of experience of a reputable mezzanine financing provider can be advantageous for senior lenders, especially if the borrower defaults.

According to David E. Watkins of Heitman Real Estate Investment Management in Chicago, the mezzanine financing provider typically negotiates for several elements in the intercreditor agreement. The big three are listed below:

  • Notification of non-payment or default on the first mortgage. The mezzanine lender wants to know, from someone other than the owner, that the property is being managed professionally.
  • The right to cure any default on the first mortgage. The mezzanine position wants to protect itself by taking over the property and not allowing the first mortgage to foreclose and take possession.
  • The right to foreclose on the property if the owner fails to pay the mezzanine position. First lenders rarely agree to this clause, as a building that is in foreclosure creates uncertainty among existing tenants (who might elect not to pay rent) and prospective tenants (who might view the property as tainted and unstable).

Mezzanine Financing Example Structure

What makes the intercreditor agreement unique is how the instrument secures the mezzanine investor’s interest. It’s common that the agreement secures a 100% interest in the company which owns the underlying property through a bankruptcy remote “special purpose entity”  holding company. This entity will be loaded with special covenants and restrictions and would be structured to ensure the borrower is limited in its ability to file for bankruptcy. An independent director may be appointed as well in order for the special purpose entity to maintain neutrality. The diagram below illustrates what this hypothetical structure might look like:

mezzanine financing intercreditor agreement


As shown above, Plaza Building Holdings LLC is the special purpose entity which secures a 100% interest against the borrower, Plaza Building LLC.  Plaza Building LLC holds the ownership interest in the subject property. The borrower will then make payments to both the mortgage lender and the mezzanine financing provider.


Mezzanine financing can provide borrowers the necessary financing to get a deal done, but it doesn’t come without risk. If a project experiences cash flow shortfalls or otherwise gets stuck in a down market, sponsors/owners will have less control and flexibility in the deal. This article outlined mezzanine financing basics and also covered the importance of the intercreditor agreement.

The Definitive Guide to Real Estate Crowdfunding

You’ve seen the news headlines about real estate crowdfunding and how it is changing the commercial real estate industry. In this article we’ll cover real estate crowdfunding in depth and give you a solid overview of what is possible with crowdfunding real estate investments and also where you need to be cautious. Note that this article has been updated as of December 2015 to reflect the latest Title III regulations, which allow non-accredited investors to fully participate in investment crowdfunding.

The JOBS Act Gives Birth to Real Estate Crowdfunding

It’s hard to be on the web without coming across an article about some new crowdfunding startup. The power of using a group of strangers to raise money for everything from funding a children’s TV program about the power of reading to finding investors for a promising new commercial real estate venture seem to be the fulfillment of all the promises of what the Internet could be. But, not all crowdfunding is the same. When the JOBS Act was signed in 2012, it was, in part, targeting a very specific type of crowdfunding.

Consumer Crowdfunding and Investor Crowdfunding

Kickstarter is the most famous crowdfunding platform in the world. But, Kickstarter is a consumer facing platform. It does not allow people to invest in companies and products in the strict legal and financial sense. Instead entities post a project on Kickstarter and ask for donations. Often, the companies promise that sponsors will be given rewards at certain levels. But, one thing they cannot promise is shares or any type of financial return on an investment. Instead sites like Kickstarter are really offering the chance for companies to get people emotionally invested and to pre-purchase products, but not to raise investment capital.

While Kickstarter has funded some impressive products, allowing a handful of entities to raise money in the seven figures, it and other consumer facing platforms pail in comparison to what investment crowdfunding can do.

Companies who are seeking infusions of capital used to be strictly limited on who they could approach because of SEC rules about solicitations and accredited investors. But, with the JOBS Act, investment crowdfunding is possible. If the proper procedures are followed, a company that needs accredited investors doesn’t have to be limited to the people in their network. Instead they can recruit investors from anywhere, so long as they meet the SEC requirements for being an accredited investor. The investors in these types of ventures get equity, subjecting them to the risks of losing their investment and giving them access to the rewards of a successful business.

Even more exciting is that investment crowdfunding is not limited to accredited investors. Under certain conditions, regular consumers can receive the benefits of investment crowdfunding. They can place their money in real estate projects all over the world, and grow their nest egg from their home computer.

Crowdfunding is Changing Real Estate Syndication

Prior to the JOBS Act, one of the major ways real estate projects pooled financial resources was through syndication. Syndication has been used for generations in real estate investments. In a real estate syndicate a sponsor would find the property and manage the transaction and put up some small percentage of the capital for the project. Investors would then fund the majority of the project and the profits from the project would be split according to the equity invested.

The problem with syndication is that under the rules that govern investments it was difficult to find investors. Rules limited who you could market to. You almost always needed some pre-existing relationship outside of the investment with a potential investor before you could solicit him or her. Sponsors sometimes would spend months or years making connections and going to networking events with the sole purpose of creating pre-existing relationships to later leverage into syndication possibilities. The investors themselves often had to meet specific requirements before you could legally allow them to invest money in your project.

Real estate crowdfunding uses the same principles of pooling capital as syndication, but leverages the changes in the rules brought by the JOBS Act to make it easier to find investors. Crowdfunding is like syndication, only with more latitude in the solicitation rules and without the need for preexisting relationships between the sponsor and the investors. In some cases you can also seek out investors who traditionally would not have been eligible to invest in a real estate syndicate because they lacked sufficient income or assets to qualify as an accredited investor.

Brief History of the JOBS Act

President Obama signed the bipartisan Jumpstart Our Business Startups Act (JOBS Act) on April 5, 2012. The bill made several sweeping changes to securities law and modernized many aspects of the way startups were treated by the law. One of the biggest changes was the legalization of investment crowdfunding.

The JOBS Act is made up of seven different titles:

Title I: Reopening American Capital Markets to Emerging Growth Companies

Title II: Access to Capital for Job Creators

Title III: Crowdfunding

Title IV: Small Company Capital Formation

Title V: Private Company Flexibility and Growth

Title VI: Capital Expansion

Title VII: Outreach on Changes to the Law

The biggest changes for real estate investing purposes are mostly in Title I through Title IV. These sections of the law also required the most action from the SEC.

Although the law was passed in 2012, various elements only took effect later. The SEC was required to implement several new rule changes before the law could fully take effect. The SEC enacted the last major piece of the legislation with the approval of a set of regulations for Title III in October of 2015.

Regulation D: What Can You Advertise?

The big advantage to crowdfunding over traditional real estate syndication is the ease of finding investors for a given project. But, the SEC has traditionally only allowed advertising and marketing, also known as solicitation, under very narrow circumstances for investment projects. But, crowdfunding will not work without the ability to advertise offerings to investors.

The Regulation D Limits

Regulation D allows smaller companies to raise capital without going through the onerous and expensive process of registering securities with the SEC. However, the trade off for taking advantage of Regulation D has traditionally been Rule 506 of Regulation D. Rule 506 forbids “general solicitation” of investors. This means, among other things, that companies couldn’t use mass market advertising to raise attention about the offer. Under the language of Rule 506 and the narrow interpretations, it also meant that some type of pre-existing relationship be present before a project sponsor could approach an investor with an opportunity.

The trade-off for this general solicitation ban was that non-accredited investors could be approached, so long as they were sophisticated and were given the type of information that would be required in a public offering that was to be registered with the SEC.

The purpose of the ban against general solicitation in private offerings was to prevent fraud and protect investors, especially the non-accredited investors that had access to Regulation D private offerings.

When the JOBS Act was passed, Rule 506 of Regulation D meant that real estate crowdfunding companies couldn’t exist because being on the web in any way that attracted investors would be general solicitation.

2013 Changes to Regulation D

The SEC finally made significant changes to Regulation D in 2013 to begin making investment crowdfunding possible. The biggest change was the formulation of rule 506 (c), which among many other things, allowed for private offerings to begin general solicitation.

However, the SEC remained concerned about possible fraud on the parts of startups and the ability of bad actors to gain control of weak or unsuspecting companies and use them to commit fraud or other kinds of bad acts. As a result, when the SEC created an exemption from the general solicitation ban, it also increased other fraud safeguards, which make it more challenging to recruit investors to a private offering.

The Changes and the Rise of Crowdfunding Portals

While many investors were unhappy that the SEC didn’t make it even easier for private offerings to attract investors, the investment crowdfunding sector began setting up shop. Platforms, including many real estate investment crowdfunding startups, began to raise capital and plan to begin operations now that they could qualify for the exemption to the general solicitation ban.

The 2013 changes redirected the concern of investment projects from the solicitation ban, to the new strict requirements for verifying investors were accredited. The regulations for Title III of the JOBS Act opened up some opportunities for non-accredited investors. This leaves portals the choice of two different groups of investors to target. They can work under the constraints of Regulation D and Rules 506 and 506(c) and pursue accredited investors, or they can work under they even stricter constraints for Title III that allow for the targeting of non-accredited investors.

Accredited Investors and Rule 506 and 506(c)

Most real estate projects are undertaken by relatively small companies or syndicates that use the private offering provisions of Regulation D to avoid the burdensome registration requirements that they would otherwise have to fulfill. Under Rule 506 before the 2013 changes, unaccredited investors could invest in these types of projects, but the company had to obey the solicitation ban. But, as required by the JOBS Act, the SEC amended rule 506 by adding Rule 506(c).

The Burden of Certifying Investors

Rule 506(c) eliminates the general solicitation ban, but only allows accredited investors access to the project. It also requires the company to undertake the responsibility of verifying that every investor is an accredited investor. The verification process can be time and labor intensive. Most companies lack the internal resources to verify investors, and instead increasingly outsource this task to third parties. However, the company itself remains responsible for the adequacy of the verification.

The SEC defines an accredited investor as someone who meets one of two requirements. They must either have a net worth of at least $1 million, not counting their primary residence, or have an income of $200,000 for single investors and $300,000 combined for a married couple, a year, for the past two years.

Verifying that someone is an accredited investor is often more complicated than just looking at a tax return, and can be as involved as a general financial audit. While any number of firms offer to verify investors, there is some concern about firms too anxious to provide positive results for their customers and introducing fraud into the system.

Does Solicitation Increase Fraud?

The stated purpose of the general solicitation ban was to lessen instances of fraud in private offerings. Many at the SEC and in private watchdog groups worried that allowing any exemption to the ban would increase fraud. To counterbalance this new threat of corruption, additional safeguards, including the requirement to independently verify investors, were added. But, it remains unclear if there is any link between solicitation and fraud in the first place.

SEC enforcement actions since the enactment of Rule 506(c) have not shown any increase in fraud, but instead have shown the SEC’s desire to crack down on so called broker-dealers, even in cases completely absent of fraud.

The SEC requires brokers register with the SEC, but the agency seems to be widening whom it considers to be a broker. Anyone who receives compensation, even a company employee, for helping to find investors might need to register as a broker to avoid negative SEC consequences. The SEC seems to be sending the message there is not any exemption to this registration requirement.

Does Rule 506(c) Apply to Crowdfunding?

When the SEC made the changes to Rule 506 it was enacting Title II of the JOBS Act, which does not specifically cover crowdfunding. Instead, Title III of the JOBS Act is the investment crowdfunding part of the legislation. Because the SEC took so long to enact Title III, many crowdfunding portals initially focused only on accredited investors.

506(c) is intended to only cover private offerings to accredited investors. However, many real estate crowdfunding and investment crowdfunding platforms made their offerings fit not under the actual crowdfunding part of the Jobs Act, but instead under the Title II rules.

The official position is that Rule 506(c) does not apply to crowdfunding, as that will require further rulemaking at the SEC. But, so long as companies follow all of the rules and regulations, including those that require investor verification, they may be able to create an offering that looks like investment crowdfunding, but is legally just a private offering.

Regulation A+: What Needs to be Registered?

The SEC issued changes to Regulation A+ as part of its duties under Title IV of the JOBS Act in March of 2015. Like the earlier Rule 506 and 506(c) changes, these regulations do not deal directly with the investment crowdfunding portions of the JOBS Act. Many of the provisions of Regulation A+ opened up real estate investment opportunities to non-accredited investors.

The New Regulation A+ Changes

Regulation A lays out the requirements for registering securities with the SEC. The problem with the original Regulation A is that in addition to the federal registration rules, companies have to also comply with different state registration rules in every single state where the securities are sold.

Regulation A+ has two different tiers. Tier I offerings are any offering under the regulation where $20 million or less in capital is raised within twelve months. These offerings will still require companies to register securities with both the SEC and state regulators. Tier II offerings are those there the company raises more than $20 million and less than $50 million within twelve months. Companies raising more than $50 million are not eligible for Regulation A+ treatment.

Under the March 2015 changes SEC rules will preempt state registration rules for any Tier II offerings. Additionally, anyone can invest in Regulation A+ offerings, no matter what tier. Even non-accredited investors can participate in Regulation A+ offerings.

There is a catch with the new regulations. There are strict limits to the amounts non-accredited investors can invest in these offerings. The amounts vary depending on net worth. However, unlike the burdensome requirements under Regulation D Rule 506(c), investors under Regulation A+ can self certify. This saves companies from what could have been a verification process even more cumbersome than the Rule 506(c) one.

Other changes include the requiring audited financial statements for companies seeking Tier II offerings and requiring investor circulars be pre-approved by the SEC.

How Does Regulation A+ Impact Crowdfunding?

Because Regulation A+ does not have a general solicitation ban and non-accredited investors can participate in these offerings, it seems possible for a real estate project to get capital from a large dispersed group of people in a similar way to crowdfunding.

Any real estate crowdfunding targeted at non-accredited investors will have to meet the requirements the SEC announced in October 2015 as part of its regulations for Title III investment crowdfunding.

What is legal under Regulation A+ is “accredited crowdfunding”. Offers that conform to the rules of Regulation D Rule 506 (c), where only verified accredited investors participate is the type of “accredited crowdfunding” that is legal. But, likely few real estate crowdfunding projects will be pursued on this basis now that the SEC has finally opened the way for investment crowdfunding as long anticipated when the JOBS Act was passed in 2012.

Some platforms were already working on helping to attract non-accredited investor money to real estate projects in compliance with Regulation A+ prior to the most recent regulations. This included providing detailed disclosures and having a system for investors to self-certify. However, the SEC will likely not allow this type of runaround of its crowdfunding regulations now that they have been approved.

What Are the Advantages and Disadvantages of a Regulation A+ Offering?

The biggest advantages of a Regulation A+ offering include being able to use advertising to access more capital from a bigger pool of investors and, in many cases streamlined registration requirements. However, there are several significant downsides to one of these offerings as well.

Regulation A+ only allows for streamlined registration in projects between $20 million and $50 million. If a project is smaller, it will still have to abide by both state and federal registration requirements. If the project is smaller than $5 million, it’s not clear that a Regulation A+ offering can even be made.

The new changes also require a lot of expensive audited reports and regulatory paperwork. Regulation A+ may be a great vehicle for fast growth companies and real estate projects that are large in scope, but the reporting requirements will most likely be too expensive for smaller operations.

Title III Crowdfunding Regulations

After more than three years of waiting, the SEC finally released the proposed regulations for Title III of the JOBS Act. This step will finally allow non-accredited investors to fully participate in investment crowdfunding. The rules will not be in full effect until June 2016, but the process for online crowdfunding portals to register with the SEC will begin the end of January 2016.

The Rules for Investors

While non-accredited investors will be able to participate in crowdfunding, individuals will be limited in the amounts they are able to invest. Investors with a net worth of less than $100,000 can only invest either $2,000 or 5% of their annual income or net worth, whichever is greater, a year. This means that most investors in this category are limited to investing less in equity crowdfunding than they can put into an IRA each year.

Investors with a net worth of $100,000 or more can only invest up to 10% of the lesser of their net worth or annual income a year in equity crowdfunding securities. No investor is allowed to purchase more than $100,000 in crowdfunding securities in any 12-month period.

Investors will not be allowed to sell their crowdfunding securities for at least one year in most circumstances. Investors will not be required to register their crowdfunding securities so long as the issuer is in full compliance with SEC reporting obligations is has less than $25 million in assets.

The Rules for Companies and Sponsors of Crowdfunding Projects

Companies that wish to raise money through equity crowdfunding, whether for real estate investment or any other reason, can only raise $1 million in a 12-month period. Companies will also be required to use a portal or broker-dealer that has already registered with the SEC to handle the offerings.

Companies will also face extensive reporting and disclosure requirements under the new regulations. Companies will need to disclose information about the officers, directors, and owners of more than 20% of the company. The company must describe its core business and how the money raised through crowdfunding will be used. Pricing information such as the method for determining price of the securities, the fundraising goal, and the deadline for the fundraising must also be disclosed to investors.

The SEC also requires companies seeking to make a Title III equity crowdfunding offer to disclose details about the ownership and capital structure. Any select-party transactions must also be disclosed. Companies will need to describe all of the material terms of any indebtedness along with a statement about the company’s financial condition.

In most cases, first time crowdfunding efforts will not require an audited financial statement. However, a reviewed financial statement, at a minimum, will always be required. Under certain conditions after the first round of crowdfunding, an audited financial statement will be required.

The Rules for Crowdfunding Platforms

The proposed SEC regulations require that all equity crowdfunding take place through a SEC registered broker dealer or portal and that the funding takes place exclusively online.

The funding portal is a new type of SEC registered entity. Registration for funding portals will open the end of January 2016. The platforms that will manage the equity crowdfunding process for companies will be required to provide investors with the mandatory educational materials, act to reduce the risk of fraud in the system, disseminate or make available all the information about the offering and the issuer, and provide communications channels to allow for discussions about the offering on the platform. These requirements are on top of the main job of the portal to actually facilitate the offering and sale of crowdfunding securities.

The portals are prohibited from making any investment advice or recommendations. The portals are also banned from soliciting the offers to buy securities offered on the portal website. This includes a prohibition on soliciting purchases or sales of the securities available on the portal website.

Portals are also not allowed to hold, possess, or handle investor funds or securities. Many restrictions also limit the ability of a funding portal to compensate people for solicitations.

Possible Drawbacks to the New Regulations

While no one is accusing the SEC of acting rashly with its latest regulations on investment crowdfunding, many have expressed concerns about the regulations being too limiting.

The two biggest concerns are the $1 million annual limit and the exhaustive reporting and disclosure requirements. For real estate investors the $1 million annual limit immediately takes many types of lucrative commercial and residential real estate projects off of the table. Non-accredited investors may be left with only investing in smaller projects that often have lower rates of return.

The reporting and disclosure requirements will be expensive to implement, monitor, and maintain. There is some concern that when combined with the $1 million annual limit on securities sold through crowdfunding, the cost of the disclosure requirements will be too onerous for most real estate projects.

What Can Legally be Done Now?

The SEC has created two different investment crowdfunding tracts. Non-accredited investors will be limited to opportunities governed by the new Title III regulations. Accredited investors will be able to invest in the kinds of crowdfunding deals governed under the revised Regulation D and Regulation A+.

The Title III regulations will not be in full effect until the middle of 2016. Non-accredited investors will have to wait until then to take advantage of investment crowdfunding.

Even though a full-fledged real estate crowdfunding platform is not yet legal, accredited investors can continue to take advantage of investment opportunities under Regulation D Rule 506 and 506(c) and Regulation A+. Many of these opportunities provide many, if not all, of the advantages of investment crowdfunding to both the investor and the company issuing the securities.

What Happens When a Commercial Tenant Files Bankruptcy

Often commercial landlords have clues that a tenant is going to be filing for bankruptcy. Rental payments are often late several months in a row. Sometimes the tenant falls more than a month behind on the rent. But, it can still be shocking when a landlord opens the mail and instead of a rent check receives a notice from the Bankruptcy Court.

What Happens When You Get Notice of a Tenant’s Bankruptcy?

Most of the time commercial property owners will receive notice about a tenant’s bankruptcy filing from a letter sent by the Bankruptcy Court. That initial notice is called the “Notice to Creditors”. This letter gives the address of the court, the case number, and several important dates in the case for creditors.

The notice also signals that something called the “Automatic Stay” is in place. When any type of bankruptcy is filed the court automatically issues an order to all the creditors that they are not to pursue any collection actions. The automatic stay freezes all attempts to collect debts. This includes eviction proceedings and sending collection letters for back rent.

Because bankruptcy and creditor’s rights issues can be complicated and technical, the net step is to consult with a creditor’s right attorney. If the landlord and tenant are in the middle of eviction proceedings the landlord should let the court handling the eviction know about the bankruptcy. The tenant probably will as well, but failure to notify the court can have severe consequences for the landlord.

If a creditor doesn’t obey the automatic stay they can be held in contempt of the Bankruptcy Court and face paying a stiff penalty.

Not All Bankruptcies Are the Same

There are several different types of bankruptcy filings. A Chapter 7 bankruptcy seeks to erase all of the debts of the debtor. This most likely means you will be loosing out on back rent and that the tenant will not be continuing to occupy the property.

Businesses can also file a Chapter 11 bankruptcy. This allows them to restructure the debt. This often means that the tenant will want to continue to operate and will work out a plan with the supervision of court that will include payment of any back rent to the landlord.

If the business is small or has small enough debts to qualify, they can also file a Chapter 13 bankruptcy. Like Chapter 11, this type of bankruptcy looks to restructure debts and create a payment plan for creditors. Not all creditors will receive all of the money owed, but if the tenant plans on continuing to rent the same property, the landlord stands a better chance of eventually recovering back rents.

Protecting Your Commercial Landlord Rights

It can be frustrating to be stuck with tenants that are behind on their rent. Landlords can go to the bankruptcy court to ask for relief from the automatic stay. This means they seek permission to continue collection activities.

Depending on each state, landlords who are already in eviction proceedings often can get the right to continue to proceedings. However, the tenant may also have the right to cure the breach of the rental contract by paying the back rent.

Even if eviction proceedings have not started, landlords can still seek to collect back rent by getting relief from the bankruptcy stay. Typically, Bankruptcy Courts will not allow a tenant to stay in possession of the space if they are not current on rent or do not have a plan to make future rent payments and repay past due rent.

While bankruptcy is setup to give debtors an opportunity to get a fresh start or restructure debts, there are many protections in place for creditors. Landlords with tenants still in possession of the property have some of the strongest rights of any creditors and are often some of the first creditors to get paid from the bankruptcy.

However, to enforce their rights, landlords must meet all the Bankruptcy Court deadlines for filings and attend, or have their representative attend, they key hearings dealing with the lease.

If the landlord does not seek to actively protect their rights, the Court is not likely to do it for them.

If the tenant is seeking to stay in possession of the property and restructure their debts, the landlord won’t have many options. However, if after the bankruptcy the tenant fail to live up to the commitments made under the bankruptcy plan, the landlord will be able to remove the tenant and seek to collect past due rent, but they may have to get permission form the Bankruptcy Court first.

Tax Consequences of a Tenant’s Bankruptcy

Once a bankruptcy is completed, the landlord, even if the tenant cures any past due rent, will still be in a worse financial position than before. The landlord may have lost the right to collect some of the late rent interest and penalties the rental agreement calls for. In the worst cases the landlord will have a vacant space to fill and be out the expected future rent and some amount of past due rent.

Creditors such as commercial landlords are able to deduct the losses and legal expenses on their taxes. The losses from the future rent cannot all be deducted at one time. But, so long as the landlord is unable to fill the space, that loss is deductible in the tax year it occurs. As always, it’s best to consult with a CPA on all tax matters.

Because bankruptcy can add significant expense and increase the time it takes to remove a delinquent tenant, landlords should not allow commercial tenants to fall far behind on rental payments. But, even landlords who are vigilant about enforcing rental contract provisions may still find themselves on the receiving end of a bankruptcy notice.

The filing of the bankruptcy may not mean the end of the landlord–tenant relationship. The landlord may have the tenant for months or years afterwards. If a commercial landlord receives a bankruptcy notice they must take action right away to seek professional guidance and to protect their rights.


In this article we talked about what happens to a landlord when a tenant files for bankruptcy. A tenant bankruptcy can present several challenges to a landlord. Most notably is the Automatic Stay, which is when the court automatically issues an order to all the creditors that they are not to pursue any collection actions. This article gave and overview of what happens when a tenant files for bankruptcy and also discussed some potential solutions. However, as with all legal matters, it’s best to consult with competent legal counsel.

What is NPV and How Does It Work?

The Net Present Value, abbreviated simply as NPV, is one of the most important concepts in finance and commercial real estate. Compared to the Internal Rate of Return, the concept of NPV is easy to understand, yet it’s also still commonly misunderstood by many commercial real estate and finance professionals. In this article we’ll discuss the concept NPV in depth and leave you with a solid understanding of the logic and intuition behind the Net Present Value.

What Is NPV?

First of all, what exactly is NPV? Net present value (NPV) is defined as an investment measure that tells an investor whether the investment is achieving a target yield at a given initial investment. NPV also quantifies the adjustment to the initial investment needed to achieve the target yield assuming everything else remains the same. Formally, the net present value is simply the summation of cash flows (C) for each period (n) in the holding period (N), discounted at the investor’s required rate of return (r):



If all of this math scares you don’t worry, we’ll walk through some detailed examples next that will leave you with a solid intuition and understanding of NPV.

NPV Intuition

What’s the intuition behind NPV? Here’s a simple way to think about the net present value:


NPV = Present Value – Cost


The net present value is simply the present value of all future cash flows, discounted back to the present time at the appropriate discount rate, less the cost to acquire those cash flows. In other words NPV is simply value minus cost.

What’s does NPV mean? When NPV is viewed as value minus cost, then it’s easy to see that the NPV tells you whether or not what you are buying is worth more or less than what you’re paying.

There are only 3 possible categories NPV will fall into:

  • Positive NPV. If NPV is positive then it means you’re paying less than what the asset is worth.
  • Negative NPV. If NPV is negative then it means that you’re paying more than what the asset is worth.
  • Zero NPV. If NPV is zero then it means you’re paying exactly what the asset is worth.

NPV Examples

Let’s take a look at a few examples to see exactly how to calculate and interpret the net present value or the NPV. First of all, let’s take a look at a sample set of cash flows:

What is NPV Cash Flows

The above set of cash flows shows an upfront investment of -$100,000 (this is a negative number because it’s money leaving our pocket) that returns $10,000 at the end of each year for 5 years, and then at the end of year 5 the original $100,000 investment is also returned. As shown, when an internal rate of return or IRR is calculated on this set of cash flows, we get 10%. That means that the percentage rate earned on each dollar invested for each period it is invested is exactly 10%. So, what about the NPV, the other commonly used discounted cash flow measure?

What is NPV

As shown in the diagram above, when we calculate an NPV on this set of cash flows at an 8% discount rate, we end up with a positive NPV of $7,985. As clearly demostrated above, NPV is calculated by discounting each of the cash flows back to the present time at the 8% discount rate. Then, each of these present values are added up and netted against the initial investment of $100,000 in order to find the net present value. This is exactly how NPV is calculated, step by step.

Let’s take another example of calculating NPV using the same set of cash flows, except with a different discount rate.

negative NPV

In this second example the same exact process is followed in order to calculate the net present value. However, this time we are using a 12% discount rate instead of an 8% discount rate. As shown above, each future cash flow is discounted back to the present time at a 12% discount rate. Then each of these present values are added up and netted against the original investment amount of $100,000, resulting in an NPV of -$7,210.

Notice that when the discount rate is lower than the internal rate of return, our NPV is positive (as shown in the first example above). Conversely, when the discount rate is higher than the IRR, the resulting net present value is negative (as shown in the second example above). Intuitively this makes sense if you think about the discount rate as your required rate of return. The IRR tells us what “return” we get based on a certain set of cash flows. If our required rate of return (discount rate) is higher than the IRR, then that means we want to earn more on the set of cash flows that we actually earn (the IRR). So, in order for us to earn more on a given set of cash flows we have to pay less to acquire those cash flows. How much less? Exactly the amount of the net present value.

Let’s take a final example to see what happens when the discount rate is exactly equal to the IRR:

what is zero NPV

As shown above, when the discount rate is exactly equal to the IRR, then the resulting NPV is exactly equal to zero. Why is this? Well, intuitively if you think about the IRR as the actual return you get from a given set of cash flows, and the discount rate as what you want the return to be from the same set of cash flows, then when these are both equal, NPV will be zero. This means what you want to earn on an investment (discount rate) is exactly equal to what the investment’s cash flows actually yield (IRR), and therefore value is equal to cost.

NPV and The Discount Rate

In order to fully understand how to calculate the net present value you’ll first need a solid understanding of the time value of money. Assuming you’re comfortable with the time value of money and specifically with calculating present values, then you’ll be quick to recognize that the discount rate used has a big impact on determining the present value of future cash flows.

So, what discount rate should you use when calculating the net present value? One easy way to think about the discount rate is that it’s simply the required rate of return that you want to achieve. The discount rate is what you want, the IRR is what you get, and the NPV quantifies the difference. Check out our article on the discount rate for a much more in depth look at this concept.


What is NPV? In this article we discussed what NPV is, detailed how it’s calculated as well as the intuition behind what it means. We also covered some common misconceptions and mistakes and finally we tied it all together with some relevant examples. Once you look at how NPV works, step-by-step, it’s easy to see that NPV is simply value minus cost.