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REAL ESTATE FUNDAMENTALS & SYDICATIONSFINANCING
PeerRealty
SOURCING DEBT
Typical Debt Providers– Mortgage Brokers– Mortgage Bankers– Commercial Banks / S&L / Credit Unions– Life Insurance Companies– Seller Financing– Sale Leaseback Transactions
COMMITMENT LETTERGenerally, upon review of the contemplated transaction, the lender will issue a Commitment Letter setting forth the terms under which they will provide debt financing.
The Commitment Letter will generally state:– The Parties – The Borrower and the Guarantor– Loan Amount and Rate– Dates / Amounts of Repayment– Security (Real Estate, Guaranty or both)– Commitment Fee– Timeframe
TYPES OF DEBT• Fixed Rate Financing – Typically, fixed rate debt is based off the
Ten Year Treasury (2.25% on 3/23/11).– The Ten Year was at 4.7% (2/2007). 3.5% (4/2008), 2.6% (2/2009), 3.6%
(3/2010) and 2.86% (3/2011).
• Floating Rate Financing – Floating debt is traditionally based off LIBOR (0.24% on 3/23/11).– LIBOR was at 5.4% (2/2007). 2.7% (4/2008), 1.8% (2/2009), 0.4% (3/2010)
and 0.25% (3/2011).– Depending on which type of financing is used, either the Borrower or Lender
will assume the interest rate risk.
• Fully and Partially Amortizing – The Borrower pays the interest and reduces some or all the principal over the life of the loan.
• Interest Only (IO) – The Borrower only repays interest not
principal.
FLOATING RATE DEBT• Floating rate debt usually has a LIBOR floor and ceiling
which states that in no event can the rate be more or less than X%.
• Floating loans without caps should never be accepted.
• Caps can be measured annually, at time of payment or over the life of the loan.
• Floating rate debt can also come with the option to covert to fixed rate financing at some point. – Long term floating debt should be avoided or the
Borrower should maintain the ability to close down the credit facility and refinance to obtain a better rate.
LOAN AMOUNT AND RATEThe loan amount (or LTV) is a percentage of the real estate’s value, adjusted for the risk involved with the asset(s).
– The LTV is usually stipulated in the commitment letter and states that the lender is required to lend X% off the appraised value.
In a healthy market, the rate on fixed financing is generally 100-150 bps over the ten year on fixed and 200-300 bps over 6 Month LIBOR on floating rate debt.
DEBT YIELD• Debt yield is the lenders cap rate.
NOI 100,000$ Price 1,000,000$
NOI 100,000$ Loan Amt 650,000$
10%=
Cap Rate
Debt Yield (65% LTV)
= 15%
•Generally, debt yields are 9% - 12%.
DEBT SERVICE COVERAGE RATIO
• In general, it is calculated by: DSCR = Net Operating Income / Total Debt service
• The debt service coverage ratio (DSCR) is the ratio of net operating income to debt payments on a piece of investment real estate. It is a popular benchmark used in the measurement of an income-producing property’s ability to produce enough revenue to cover its monthly mortgage payments. – The higher this ratio is, the easier it is to borrow money for the property. The phrase is
also used in corporate finance and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition, a loan covenant, or a condition of default.
• Typically, lenders look for a DSCR of at least 1.5, but at the minimum, the ratio should be over 1. – If a property has a debt coverage ratio of less than one, the income that property
generates is not enough to cover the mortgage payments and the property’s operating expenses. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough revenue to cover annual debt payments.
LENDER FEES• Lenders love fees.
• Borrower’s usually have the ability (given decent credit) to have some of the fees waived or reduced.– In the event of excessive fees, try and negotiate
them down.
• Origination /Commitment Fees – Fees for originating the debt and the commitment of the same.– Remember, once the debt is committed, the lender
has foregone the use of those funds for something else.
• Inclusion Fee – Inclusion fees are commonly associated with credit facilities and are a fee to cover the lenders cost of underwriting the transaction.
AMORTIZATION• Full Amortization – At the end of the loan’s term, all of the
principal (borrowed funds) and interest will be paid back.
• Partial Amortization – At the end of the term, some of the principal will have been repaid and the Borrower will still be responsible for a balloon payment to cover the then remaining principal.
• No Amortization / Interest Only – At the end of the loan, no principal has been repaid and a larger balloon payment (often called the “bullet”) is due.
ZERO CASH FLOW FINANCING• Zero Cash Flow Financing is a fully amortized loan whose
term expires at the expiration of the lease.– THIS MEANS THERE IS NO CASH FLOW FROM THE REAL
ESTATE EVER!– At the end of the lease term, the Borrower owns 100% of
the fee simple interest in the property free and clear.
• These are popular with single-tenant net leased investments, particularly CVS Drug Stores.
• Zero’s are often used as estate planning techniques for fiscally irresponsible children/beneficiaries.
BORROWER LIABILITY• Recourse Loans – If the loan is recourse, then the Borrower
(and if the Borrower is a legal entity most likely the principals behind it) are personally liable for repayment of 100% of the loan and interest amounts.
• Non-Recourse Loans – No Borrower liability other than “Bad Boy” and environmental.– “Bad Boy” Acts – Fraud, misrepresentation, breach of
representations and warranties.
LOAN PREPAYMENTS
Prepayment• Terminate Credit Risk• High Risk Loans Prepaid at
Full Value• Minimize Interest Rate Risk• Reinvest at Higher Rates• Prepayment Penalty /
Premium
No Prepayment• Lower Interest Rates on
returned funds.• No prepayment penalty. • Refinance at lower rates.
LOCKOUT PERIODS• Lockout periods prohibit repayment of the loan for a
stipulated duration. • More common on shorter term (3-5 year) loans.
– Typically, Borrowers push back if the lock out period is greater than 5 years as this will limit their ability to dispose or refinance the asset.
• After the lockout period has expired, prepayment is allowed. If the loan is securitized, then defeasance is the only option.
• On “second’s” or mezz debt, the lockout period is usually shorter, around 12-18 months. – The reason for the shorter lock out period is that the
these loans typically come at higher than standard interest rates and the lender does not want the borrower to be able to refinance out in a short period of time.
DEFEASANCE• Defeasance is the process whereby the collateral
or security for the loan is replaced with other collateral, typically bonds or securities.
• By defeasing, rather than prepaying loans, the securitized lenders are able to still retain all of their cash flow and return versus getting cashed out of the deal.
• www.defeasewithease.com
REAL ESTATE FINANCE DOCUMENTATION
• Loan Agreement – A lender's agreement to make a loan on particular terms, including interest rate, fees and charges.
• Mortgage - A mortgage is a promise in which the borrower agrees to put up the real estate as security for a loan. The mortgage is the instrument which secures the Promissory Note, in which the borrower promises to repay the loan at a certain date. The mortgage document allows the lender to force a sale of your home (foreclosure) if, for example, the borrower fails to make payments, to pay property taxes or insurance, or keep other promises. In some states the mortgage document is called a "deed of trust.“
• Promissory Note - A legal contract in which the borrower promises to pay back the loan. The "promissory note" sets forth the terms and conditions that apply to the loan repayment, such as interest rate, when payments are due, where payments are made, what happens if payments are not made, etc.
• Guarantee(s) – Even in non-recourse loans, there is typically a guarantee of some kind and typically it’s a guarantee of the recourse obligations (carve outs, typically environmental).
• Cash Management Agreement – An agreement which details how cash will flow from tenant to Lender and then on to the Borrower.
MORE FINANCE DOCUMENTS• Assignment of Rents and Leases – These documents force the Borrower to
assign its interest in the rents and leases (getting at the cash flow) to the Lender to ensure that the loan is repaid.
• Environmental Indemnity – In addition to guaranteeing the recourse carve outs (as mentioned before), the Borrower will typically have to indemnify the Lender from all environmental liabilities incurred.
• Equity Pledge – The equity pledge gives the Lender the right to control, access or apply the Borrower’s equity in the real estate against any unsatisfied loan obligations. This usually comes into play when there is a forced sale of real estate.
• Interest Rate Cap Agreement – Sometimes, real estate loans have interest rate caps (this is more common when you have a line of credit than with individual loans). Interest Rate Cap Agreements will stipulate how to calculate the maximum interest rate that can be applied and is most common in floating rate loans.– Had more residential loans had interest rate cap agreements in place,
the subprime crisis could have most likely been minimized or averted.
MBS LOANS• As we have discussed in previous classes, CMBS and RMBS loans
were a very popular method of financing real estate transactions.
• MBS loans were made on an individual basis, then, per FASB, were moved off-balance sheet, placed into pools and syndicated. – The largest problem with the off balance sheet nature of these
loans was a lack of liability, on the part of the issuer, for the quality of loan and/or initial underwriting.
• The MBS loans were then cut up into slivers, based on risk profile, and sold as a security.
• While great in theory for the real estate industry, the end result, as we can see by the current economic crisis, wasn’t great.
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