BONUS – Lending/Debt Selection

If you have reviewed our past deal webinars you generally notice that we target long term agency (Fannie/Freddie) debt due to the non-recourse component. These are great loans for sure however not for every situation as they do come coupled with prepayment penalties (yield maintenance) that make it less appealing because you are going to take the hit at the end of the deal.

On a recent deal that we walked away from because we were just not able to come to a solution to the seller’s $2M+ in a prepayment penalty for the remaining years of their 8-year fixed note. These penalties can be lump sums, a % of the loan, or a hybrid model of a setup down component based on the length of the loan. We prefer to have loans with the set-down component to give us flexibility either way.

The reason for the large prepayment fee is yield maintenance. Yield maintenance means the borrower pays the lender for any interest owed (less what the lender can re-lend the money for) for the duration of the loan.

Having the right financing per project is extremely important.

Fixed/Agency debt:

Pros: 10-15-year terms with fixed interest, government backed so lower rates, interest only portions, loan can be assumed but new buyer will need to be underwritten as a new lender and buyer will want a healthy amount of time left in their adopted loan.

Cons: High yield maintenance or prepayment penalties that can take a chuck of your back end returns, if assumed you will need to use creative financing with possible seller financing or a supplemental loan

Bridge loan:

Pros: 2-7- year terms, borrower can buy a rate cap to hedge against higher rates, flexibility to sell without external factors such as pre-payment penalty, many private lenders (local banks) offer this competitive financing.

Cons: Higher rate than fixed loans, there is more risk in what the rate will do at the end of the term. However think about it… in a worse economy the rate fundamentally should go down as the FED should lower the Fed funds rate. In a good economy and good progress on the progress you should be able to refinance out of the bridge debt as planned.

Why do a bridge loan?

If we plan on holding it more than two or three years going with an agency loan will set you up with prepayment penalties. By locking in those long terms you get low interest rates but most investors don’t realize the heavy fees.

If the market goes sideways?

If the economy goes bad then the interest rates goes down. Why would we want to hold onto long interest rates (agency loans) if the economy is going to go down and so are the interest rates. And if it is a great market 2-4% rent increases or more a year then you are increasing the NOI like crazy and out of the deal hitting much higher than the proformas anyway. Kinda seems like you can’t lose??? Well if you find a property that is under market rents it sorta is.