Andrew Shook

3 Most Critical CRE Loan Refinancing Considerations

Prepayment Flexibility

Would you pay an 18% prepayment penalty...$1.75 million prepayment penalty on a $10 million commercial real estate loan? HELL NO!!!

Neither would I.

But, if your loan has a Yield Maintenance prepayment structure that would be your obligation if you sold the property 12 months after loan closing ($10 mm loan, 5.00%, 25 yr amortization, 2.50% 10 yr U.S. Treasury). I used Chatham Financial's Yield Maintenance Calculator

Brutal. Heavy prepayment structures equal a call option on your real estate equity capital and your limited partners' capital. Unless you will absolutely buy and hold the property to loan maturity, use lenders that offer no prepayment penalty or step-down prepayment.


Is Your Loan Refinanceable?

In the current market environment Debt Service Coverage Ratio (DSCR) limits available loan proceeds. Loan-to-Value (LTV) rarely constrains loan size. We discuss this dynamic in more detail here

Lenders "adjust" vacancy rates and expenses to market. Some lenders then deduct reserves prior to calculating DSCR (NOI - Reserves = Net Cash Flow). Net Cash Flow can be 15%+ less than NOI. Ouch!

Do you know what loan amount your NOI will support? Do you know which lenders DO NOT hold back reserves? Use this tool for the former and contact us for the latter. 

Required DSCR and reserves directly impact our next topic...


Cash Return On Equity

Challenge: in 5 seconds or less identify the loan option that provides the highest Cash ROE @ 70% LTV.

  1. 4.25% on a 25 year amortization 
  2. 4.65% on a 30 year amortization

Unless you have extraordinary mental math game, the answer can be figured out in your head. Many steps and the math is complex. Though a constant is the answer, it's not always intuitive (hint - low rate doesn't always win).

The fact of the matter is that borrowers do not have effective tools that allow them to compare different loan options. Bright Light developed a solution to this problem that our clients find extremely useful.


Simple and Effective

Prepayment Structure. Refinanceablility. Cash ROE. Keep these three essential factors in mind as your consider CRE loan options for your next refinancing (or acquisition).



It's what we do.

Warren Buffett - Low Fees and Transparency Win

A Simple Question

Low fees and transparency are critical to Warren Buffett, Charlie Munger and Jack Bogle.
Should they be important to you?


Low Fees in Commercial Real Estate Loans Matter

Low fees and transparency - two central themes in Warren Buffet's 2016 Annual Letter to Berkshire Hathaway shareholders. Minimizing fees and creating transparency in commercial real estate are critical given the asset's inherent leverage. CRE fees measured as a percentage of the equity are 2x - 4x greater than they appear relative to the total value of the property.


Warren Buffet, the Impact of Fees and "The Bet"

Mr. Buffet describes "The Bet" on page 21 of this year's Annual Letter to shareholders. Simply put, The Bet pits actively managed funds with high fees against a passively managed, low fee Vanguard S&P 500 index fund over a period of 10 years. Spoiler alert: one must be bold to bet against Mr. Buffett. The 10 year window closes this December.

Jack Bogle founded Vanguard. Vanguard evangelizes low fees and transparency in financial services. Mr. Buffett pays respect to Jack Bogle: 

Page 24:
"If a statue is ever erected to honor the person who has done the most for American investors, the hands- down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.

In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me."


Transparency is Critical

Mr. Buffett discusses transparency in a brilliant, non-fiction storyline beginning on page 16. The storyline points out that industry standards (and in this case GAAP) encourage behavior utterly contrary to common sense. Warren Buffett and Charlie Munger refuse to yield to such behavior. It's a good read. Check it out.


Application to Commercial Real Estate Loans

CRE market participants frequently dismiss high fees, antiquated technology and opaque processes. 

"Don't worry the Seller pays the fees."
"It's only 2%."
"Yeah, the Lender is paying me too. Sorry I forgot to mention that. Don't worry, I'm working for you. You're my client!"

The Borrower is the source of funds for all fees paid in a commercial real estate acquisition or refinance. Period. God Bless. Amen.

Let's take a quick look at the math of a traditional mortgage banking fee. Traditional mortgage banker's frequently receive far more than 1.00% per loan. Over the life of the loan the total fee can be 150 bps - 200+ bps.

I can hear you now ... "Preposterous! I've never paid a 200 bp mortgage banking fee in my life." Maybe, maybe not. Simply sum production incentives and/or servicing fees received from lenders. These fees are on top of the stated fee in your mortage banking engagement letter.  

Back to the math...

Cash Return On Equity = (NOI - Loan Pmt - Fees) / ((1 - LTV%) * Price)

The loan payment on a 6.25% cap rate acquisition financed with a 4.75% (25 yr amortization) loan consumes anywhere from 70% - 90% of NOI @ 65% LTV - 80% LTV. This is before fees.


4.87% Cash ROE. Not So Great.

Consider a $10 million deal on an industrial asset in a nice market purchased with the above parameters (6.25% cap rate with 4.75% financing) at 70% LTV with a 5 year maturity. Cash ROE comes in at 4.87%.

The financing creates a loan constant of 6.84%. Thus, the loan payment consumes 77% of NOI. Equity investors receive a rather modest 4.87% Cash ROE.

In dollar terms, there is $146,000 in cashflow available...before the $105,000 mortgage banking fee (1.00% upfront and 10 bps per annum servicing fee). THAT'S 72% OF YEAR 1 CASH FLOW. 72%!

The standard industry practice is to obfuscate this fact by financing the fee into the loan balance. The practical result is that high fees, no matter who charges them, result in commercial real estate sponsors selling a call option on the initial price appreciation of a project.

Fees and transparency matter, particularly in an asset that is leveraged 2x - 4x capital.


It's what we do.

Low Cap Rates and Maximum CRE Loan Amounts - LTV Doesn't Matter Anymore

"Rate and proceeds"...the commercial real estate industry standard for summarizing a loan in two words. In reality, CRE borrowers use "proceeds" as shorthand for loan-to-value (LTV) * Property Value. For decades, LTV has been the go-to term for comparing alternative loan proceeds.

That just doesn't work anymore.


The Reality of Commercial Real Estate Loan Sizing

Commercial real estate lenders CAP the loan amount at the lower of:

LTV Guideline
Debt-Service-Coverage Ratio (DSCR) Guideline
The current low cap rate environment creates a double whammy working against CRE sponsors. Lower cap rates drive up prices. This means more loan dollars for a given LTV. Larger loan amounts require more net operating income (NOI) dollars to cover debt service payments. It's a vicious cycle...

The vast majority of loans BrightLight arranges are constrained by DSCR and not by LTV. For those of us that can't do differential equations in our head, estimating loan proceeds based on DSCR is laborious and time consuming. And then you must compare the "DSCR Loan Amount" to the "LTV Loan Amount."


A Simple Solution


BrightLight developed a great tool to solve this problem faced by our customers. The CRE Loan Payment Calculator provides both the annual loan payment AND the minimum required NOI to support the loan amount. We provide annual loan payments and minimum required NOI for 30 year, 25 year and 20 year amortization terms at the click of a button.



It's what we do.