Debt conversion to equity or not?

[Reese Newell]

I have financed the acquisition of a property that was to be converted in to a retirement home.  The term of the investment went a little longer than expected, and I was just paid out my interest for the initial debt of ~1.1MM that went for about 8 months at a 10% rate and 0 points.  The structure to our deal was that my debt would be fully paid back sans a downpayment left in the property upon refinancing (~$360k) and I would then retain 25% equity in the deal as a preferred partner.  At the conclusion of each year, I would get a preferred payback of $36k until I had been paid back $180k of the $360k over a 5 year window.  This payback each year would drop my equity 1% each year until I hit 20%, at which point the preferred payback would end and the rest of the money would stay in.

At this point, we needed to take out loan of ~$670k to finish renovations.  The banks wanted my lien to be moved to a 2nd position.
In turn, we negotiated my rate of 12% on my money now until the completion of the renovation and refinancing from the bank.  My partners believe that the $180k that I am leaving in long term for equity should convert now from debt to equity.  I argued that it should remain debt since the house is not operational yet.  What would be your opinions on this portion of the debt and if it should convert now?

[Greg Dickerson]

Originally posted by @Reese Newell:

I have financed the acquisition of a property that was to be converted in to a retirement home.  The term of the investment went a little longer than expected, and I was just paid out my interest for the initial debt of ~1.1MM that went for about 8 months at a 10% rate and 0 points.  The structure to our deal was that my debt would be fully paid back sans a downpayment left in the property upon refinancing (~$360k) and I would then retain 25% equity in the deal as a preferred partner.  At the conclusion of each year, I would get a preferred payback of $36k until I had been paid back $180k of the $360k over a 5 year window.  This payback each year would drop my equity 1% each year until I hit 20%, at which point the preferred payback would end and the rest of the money would stay in.

At this point, we needed to take out loan of ~$670k to finish renovations.  The banks wanted my lien to be moved to a 2nd position.
In turn, we negotiated my rate of 12% on my money now until the completion of the renovation and refinancing from the bank.  My partners believe that the $180k that I am leaving in long term for equity should convert now from debt to equity.  I argued that it should remain debt since the house is not operational yet.  What would be your opinions on this portion of the debt and if it should convert now?

You need to evaluate the risk and return. Which is more valuable to you and how safe do you feel in second position vs 25% equity. Personally I would not take much comfort in second position.