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Updated almost 8 years ago, 01/03/2017
Commercial or MFH - what happens after the 7 yr fixed rate is ove
Read several times on here that people bought commercial or MFH and plan to hold 5-7 years...What happens if the market turns the other way and you can't sell, AND the fixed rate expires and you are now facing a higher rate?
I know people dont think about these things in a good market like today's... But what happened to those in the game back in 2008/2009? Did they all survived or wiped out?
My understanding is that commercial is valued based on NOI, not market conditions like SFH (I invest in SFH currently but am learning about commercial). Not sure if this was true in the last recession but worth researching. MFH is used to preserve capital as much as it is used to grow it.
People either sell or they refinance when the balloon payment comes due. Personally I'd sell to avoid maintenance issues and use the capital to expand the portfolio.
Originally posted by @Diane G.:
Read several times on here that people bought commercial or MFH and plan to hold 5-7 years...What happens if the market turns the other way and you can't sell, AND the fixed rate expires and you are now facing a higher rate?
I know people dont think about these things in a good market like today's... But what happened to those in the game back in 2008/2009? Did they all survived or wiped out?
Diane,
I provide financing on commercial loans. For people looking for a 5-7 year exit, I still recommend doing a 10 year term on their financing. I also recently recommended a 5 and 5 to a client. On the 5 and 5, they have 5 years fixed, with a reset at the start to year 6. Property would be fixed for the second five after the reset. On the 5 and 5, the client would not have a pre-payment penalty in year 6. We also had a ceiling in place so the client would have piece of mind.
Mark
Hi mark - happy new year.... So if your client can't refi at maturity for whatever reason and pay off the balloon payment, what happens then? Never experienced that?
Originally posted by @Diane G.:
Hi mark - happy new year.... So if your client can't refi at maturity for whatever reason and pay off the balloon payment, what happens then? Never experienced that?
Diane,
In the case of the 5 and 5, the loan resets at the end of 5, Borrower has security knowing that they can go to 10 years on the term.
As for reaching 10 years, certain lenders are difficult. The large bank who likes to give everyone 6 accounts, also likes to foreclose when loan comes due.
Mark
See, that is the one thing that scares me off commercial property.... LOTS of uncertainly at 10 year maturity, especially in a down market... You are getting trimmed 2-3 times at once, higher rate, lower market value, less demand if you want to exit....
LOTS of people get wiped out in 08/09?
Diane,
If you owned property in 2008, you lost significant value if you did not get wiped out. The reason to do a 10 year term is to minimize risk. If you have the right assets with the right lending, you should avoid these pitfalls. A good management team is also important.
I saw houses in California lose 60-70% of their value in between 2006 and 2009. I used to do BPOs for banks and the amount of lose during that time period broke most people.
Mark
Mark - but here is the thing... During 08/09, some of my properties were below what i paid for, but since I had 30 yrs fixed on them (I did refi a few time since then, but every refi is 30 yr fixed too), I did NOT worry at all... I knew what my expenses were and then it is just a matter of sitting thru the storm and waited out.... And it turned out to be exactly that... everything is 2X of what i paid for now....
BUT, had I not had 30 year fixed, had my had to switch into a higher rate and get my expenses out of control, or not able to refi at all, I would have been wiped out...
That is the risk I see with commercial, and that aspect of it scares me off... Am I overthinking this?
Diane,
There will always be corrections. Options exist for 30 year term on some commercial loans. FHA has an apartment loan that will go to 40 year term.
Mark
Diane
I think it depends on how you are playing commercial when you say it scares you off. If you are buying without consideration for adding value to the property, you are putting yourself at a much higher risk when a downturn hits. Since as you are probably aware, commercial property value is based on the NOI, if you simply purchase properties that you can't improve through renovations or improving the operational efficiencies of the commercial properties, simple buy something and hold it, when the income drops because you have to lower rents to keep tenants / residents in tact, the value of the property declines.
However, if you buy w/a value bent, you are essentially able to create more NOI and weather downturns better providing somewhat of a cushion. The default rate on MF loans was about 1% during the last 2008 downturn but for residential it was up to 5% and higher in some markets like Vegas and Phoenix. For MF operators w/experience, who's model was buying value add in solid (not over exuberant) markets the default rate was almost nil.
We have a partner in Houston who is vertically integrates (acquires, manages and renovates) their own properties of B/C class apts. Two years ago when oil dropped from $100 to $50 barrel, their occupancy actually went up slightly from 92 to 93% while Class A fell off a cliff in some areas down 20% or more.
Value add owners also do the following after they have purchased these properties. They will add massive value in the first few years, hence the NOI is optimized, then the property is refinanced, pulling out equity and reducing the owners risk further. We don't wait ten years for appreciation. We get if by forcing it. It's not even uncommon to go w/interest rate only loans even in today's market w/options to lock since we still are getting very attractive rates
Bottomline, when you state commercial, that's too general. Value add B/C is quite different from buying class A or just commercial at market. The former can make it thru tough times, the latter has a higher risk.
David - thank you very much for your wisdom.... So if I am hearing you right, you are saying the best way to go about MFH via the value add approach, 3-5 year in and out.....Is that right? If that is the case, then I am thinking maybe it is not for me then, which is OK.... I have a busy day job, can't really spend more than a few hours a MONTH on real estate, and need it to be extremely passive... Lol.... But I appreciate your advise...
Diane,
I am in the process of searching and trying to acquire a commercial loan. Some things to consider, after the whole housing bubble, the gov't made everyone they had control over tighten up their policies. That's why almost no one can get a loan after 2008 and cash was king. Are there 30 yr fix/30 yr amor? Yes, offer by Fannie Mae. Is it easy to get? No. If you want to acquire a property out-of-state or far away (which is the case for us, Californians), then you must have and show 2 years of multi-family ownership and experience. On top of that, the loan you get, you must have the same net worth equal to the loan amount. So if a property is 1.3 mil, you have to have a net worth of 1.3 mil for them to consider you. Which kills the point of leveraging you money when you have a small amount to start with, but it's a good protection for Fannie Mae and the secondary market.
So my point is you shouldn't be too scared because the gov't has put in place a lot of things to prevent a crash like 2008 for our generation, there will still be recessions but probably not as bad as 2008. Second, you shouldn't be scared of commercial because if you are investing as an individual, the requirements from institutions or the higher interest rate from private money wiping out your returns would prevent you from even entering into commercial real estate.
how is "net worth" defined by Fannie? money in the bank, or your equity in other property counts too? Lol
Diane,
One of the best ways to place this value add large apt approach (scale and forced appreciation) is being a limited partner where you invest money with the general partner and have a fractional ownership in it. If you'd like to get some education on it, PM me. I enjoy educating folks about opportunities in this space. That way you are more informed about opportunities. The general partner has a full time job in this space, finding great markets, solid value add opportunities and has the experience. An investor can be totally passive or as I like to tell investors, if you want to earn and learn, I'm more than happy to educate before and along the way while you hold the investment. Typical return targets are in the 10% CoC and 20% IRR range for a totally passive experience and to diversify both in this asset class and geographically, its hard to beat.
@Daniel Y. - got it..thanks
@David Thompson - this whole partner approach then depends largely on finding a reliable and trustworthy "general partner" then...
Im doing a commercial now with 30 yr amortization and 15 year fixed term (best deal Ive found) @ 4.6% 20% down. Closing in 8 days.
I personally couldn't sleep well with 5 year terms for your scenario as described. I gues the short answer is pray that everything doesnt move against you at once wiht that type of loan. 15 years allows me to exit as planned in 7-10 years, maybe a tad longer if things are still going great.
@Diane G., how do you plan to be passive with only a few hours a month of work then? Wouldn't you need a property management company that you find reliable and trustworthy to do it for you?
In the end I think you can convince yourself to do or not do anything. But the better question is to find how to do it. How do you plan to be a real estate investor but only spend a few hours a month to find and manage your deals? If you think passively investing with someone else is the right way, then how do you find reliable and trustworthy partners?
Hi Matt,
Is that from a local private lender or a bank that you have a good relationship with? I've just started my start for one in with a property in Texas and the best of what I am finding so far are 10 yr fixed/30 yr amor at 4.5%. Did you have to buy any points down? If not, I would gladly trade 0.1 of a point for 5 extra years.
@Michael Le - with my past experience, I spent LOT of time looking for the right property... But once I bought it, it is literally like 5 hours per year per each property if that much, yes, that type of "passive"....That is my model of "buy and hold"...
Now that I am trying to venture into a cash flow model, not so much "buy and hold and do nothing"... I find a whole world of things to learn...
@Diane G. In answer to your original question, Yes, I not only had a rate change but the commercial loan came due (42 unit mixed use building) requiring a balloon payment. It took about 15 months to get it refied due to the downturn in the economy and our location (tertiary market) despite having great cash flow. We worked through over 18 banks and a loan broker with his contacts before getting it done with a small local bank.
The lender called persistently (mostly low level interns), put pressure on us to get it refinance, threatened to double our payment to pay down the loan, required 90 day loan extensions (with fees). We had a perfect payment record and were working diligently to get it refied so they didn't get nasty or get lawyers involved.
Our plan in 2006 was to buy and hold for 5-7 years then 1031 into something else. Then the market turned and I still own it today, having celebrated 10 years in September. I may look for an opportunity to sell again in 2 years when my new prepayment is minimal.
LESSONS:
Our cash flow saved us. Make sure you buy right, and keep rents up to market.
Subsequent loan is 10 year with a 5 year adjustment. No more short term loans! Create as much room for options as you can.
Put together a sharp looking financial packet detailing the property, rents, expenses, along with personal financials and tax returns for both business and personal. The more of the lenders work you do the better chance at getting a smooth refi (and you look professional and experienced when you include everything they are going to ask for anyway). Once I put the packet together the refi came soon after.
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Originally posted by @Diane G.:
Read several times on here that people bought commercial or MFH and plan to hold 5-7 years...What happens if the market turns the other way and you can't sell, AND the fixed rate expires and you are now facing a higher rate?
I know people dont think about these things in a good market like today's... But what happened to those in the game back in 2008/2009? Did they all survived or wiped out?
Hey Diane. Couple of items:
1 - If the market turns, rates will generally decline
2 - Many commercial investors structure their financing to match their strategy and exit prior to maturity
3 - There are fixed loan terms of 10, 12, 15+ years and some without balloon payments (i.e. they float after the fixed period). I have a 25 year loan, fixed for 7 years.
4 - If rates are rising during your fixed period, it provides time to pay down debt. Many apartment investors are locking in for 10 years.
5 - If rates are rising, it will largely be due to a strong economy, which is good for real estate investors
6 - The default rate for apartments was minuscule during the last recession. That is why apartment financing terms are so favorable (long-term fixed low rates, 30 year amortization, non-recourse, I/O periods, favorable LTVs, assumable, supplemental loans).
7 - In cyclical markets, you do not need high leverage to achieve outpaced returns. And modest leverage in linear markets can be low risk.
Financing correctly is front and center on most commercial investors minds in good and bad markets.
Diane,
Yes, you need to do your due diligence on partners. It's not as hard as you think. Syndicators are out there, there are some on BP for instance. The syndicator has a lot riding on their reputation and track record. They should have websites, google information on the leads and make sure you are not coming up with information that is not supportive. They should be open to talk with you about their model, strategy and experiences. I share past deals with investors, like to educate them first, understand investor objectives, are they accredited (a requirement for many syndications) and if they are informed, qualified and have capital will alert them to future deals. There are several questions you can ask but basically I would look at these 3 key things for an investment.
1) Market - are the projects they are investing in markets where population and jobs are growing well above natl averages? Are they in submarkets that are in the path of progress or what are the catalysts for selecting this location?
2) Deal - look for value add period. Do the assumptions make sense ? You want conservative underwriting and assumptions. Keys are occupancy and rental projections after value add. The value add strategy and operational efficiency plans, are they straight forward and sensical? Do you clearly see how value will be created, push up NOI and increase the value fo the investment?
3) Team - do they have a track record and how long have they been doing deals, ideally through a full REI cycle. Review past deals. Is there strategy consistent and is it working?
You can ask for references. You should be able to talk direclty w/sponsors and they should be able to spend time with you educating and answering any question you have. Talk to a few of them and see what makes sense to you.
Bottomline, there are a lot of good syndicators out there and their reputation is everything. Get a bad reputation by being shady, doing bad deals and not being transparent with investors and you won't be in business very long, period. It's not easy raising capital, we want informed, educated investors that have good experiences and we want to develop long term relationship with them to help grow their wealth. Busy folks who appreciate what real estate can do but don't have time, resources, or skills to play in the big game can have it through fractional ownership. Sponsors need investors to buy these $20m - $30m deals and savvy investors can benefit greatly from partnering w/them.
@ Mike Dymski
Guys - all good posts... LOTS of food for thoughts.. Thank you...
Originally posted by @Matt A.:
Im doing a commercial now with 30 yr amortization and 15 year fixed term (best deal Ive found) @ 4.6% 20% down. Closing in 8 days.
I personally couldn't sleep well with 5 year terms for your scenario as described. I gues the short answer is pray that everything doesnt move against you at once wiht that type of loan. 15 years allows me to exit as planned in 7-10 years, maybe a tad longer if things are still going great.
Hi Matt, I am in PA too and I have a 5 unit multi-family home under contract for purchase and looking to finance it. Can you tell me which bank are you working with? I have called many banks I can only find 20 Year max amortization. 30 year amortization with 15 year fixed term @ 4.6% with 20% down seems to be a good deal. Can you help me with the bank name and the lender contact information please?
Thanks,
Saran
This is a great topic. I bought my commercial property in 2006. Lehman Brothers financed me with stated income. Because of the crash, I filed bankruptcy in 2010, but always kept my payments up. I've been trying to refinance and nobody wanted to touch it because of my bk. It appraised at 850k and that's the only reason I was approved for a 450 k refi. The reason the value increased was because of me upgrading my building all those years and the market getting better, my propertty is also in a great neighborhood.
Unfortunately now I have some violations on the building and loan can't be funded until they are fixed. Anyone have suggestions on getting funding with violations on the property?