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What are you trying to learn? Not really all that much to write on the topic. Real estate is meant to be a solid, cash-flowing asset, so you're most likely to see the equivalent of a PIK feature on debt for properties in transition or construction. Usually it will be structured as an "interest reserve" or holdback.
In other words, if the property is being acquired today for $100 and the business plan entails putting another $20 into improvements and capital costs, the lender might size the total loan to $80 but only fund $50 upfront. The remaining $30 will be disbursed to cover project costs and pay interest (which effectively results in PIK-ing, since the loan is paying itself). The expectation is that the project will be cash flowing once the reserve is fully funded, or else the sponsor will have to either put in more equity or face a default.
A client has a large PIK investment and I am trying to figure out how to value it. I traditionally work with senior mortgages or mezz and am unfamiliar with paid in kind debt.
What you described sounds like a traditional senior mortgage holdback (TILC, capex, earn out, etc). But usually in these cases interest isn't paid on the debt until it is drawn upon, even if the interest is paid out of an interest reserve line item.
What I am looking at now is an '07 vintage deep mezz strip that was converted to PIK when there wasn't enough cash flow. The interest is accruing on the face amount but will only get paid out to the extent proceeds are available upon the sale of the asset.
I just want to make sure I am knowledgable when I'm asked about it.
Valuation would just be run as a DCF with a timeline of bullshit assumptions, like anything else. Don't overthink it.
Ah I see. Yes, pretty unusual circumstance here and not what you'd see in newly originated debt. Basically sounds like a form of hope note. There's been some recent press on hope notes due to some of the earliest forms in the last cycle seeing some payoffs, but as a whole not a lot of dedicated literature to my knowledge.
As a matter of discussion, it would seem unusual and problematic for a restructuring to contemplate the face amount of deep mezz converting to PIK and accruing senior to the newly restructured equity...as you would retain the same basic problem of all overlevered real estate: the ownership responsible for putting in fresh equity is underwater and has no incentive to advance capital to protect intrinsic value.
A solution that I've often seen is where the hope note is structured in a manner such that it shares in profits AFTER the new equity has achieved a target IRR or profit (hence "hope note," since there's often little chance the note will find itself in-the-money).
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