One of the oldest of financing approaches used to fund some of the newest of projects.
The purpose of buying of real estate is to gain benefit, which usually means making money. Real estate which is income producing at the time of purchase is usually financeable, at least in part, by debt mortgaging the property.
In the event the full amount necessary to buy and develop the property cannot be covered by the first mortgage a second mortgage lender may be found. If there is still more money needed the real estate purchaser / developer may sell a part of his ownership either as common or preferred shares.
The developer could also sell for an agreed amount, an agreed percentage of the gross or defined income of the property, a royalty, for an agreed period of time. The challenge in structuring a royalty based on property income is that of assuring contractual compliance as the lenders will likely have a first call on the value of the property in the event of a default. The terms assuring contractual compliance will have to be such that whoever and however the property was completed and operational that the royalty investor’s interest was protected. I believe that we can recommend terms which will be satisfactory to both parties, the royalty issuer and royalty investors.
The terms of the royalty will have to be such that the minimum Internal Rate of Return (IRR) are achieved and using the newly developed and more appropriate Royalty Rate of Return (RRR), exceeded.
Of course, it is only fair and reasonable that the royalty issuer be granted by the investor a right of redemption permitting the termination of the royalty on terms agreed at the time of royalty purchase. The royalty issuer or others may attempt to buy some or all of the outstanding royalties at any time and on whatever terms are wished. It will be up to the royalty investors to decide if the bids are sufficiently attractive. The redemption right terms are the issuer’s worst-case scenario as the terms will be highly attractive to the investors.
Royalties can be used to supplement debt or to be used in conjunction with debt, all depending on the characteristics of the development being financed. The more projectable the revenues the better will be the terms of the royalty for the issuer. As it is likely the royalties will be for a longer period it may be assumed the revenues of the property will increase as a result of inflation.
Royalties are the better way of both investing in and financing of revenue generating real estate projects and we look forward to assisting both investors and developers.
Arthur Lipper, Chairman, British Far East Holdings Ltd.
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