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.
- 4.25% on a 25 year amortization
- 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).
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It's what we do.