Interest only loans?

[Vlad Denisov]

Hello everyone!

Question to people who own 16+units - what type of loan do you use? Do you always go with interest only or not? What is your train of thought behind this?

[Serge S.]

@Vlad Denisov the use of IO debt is used for very specific type deal. Generally a value add where there is no cash flow during the value add process. It also creates another market risk risk to the deal, especially today. In a stabilized deal, the lender will want the investor to show a minimum debt service coverage, this is a key metric for them as it shows the asset's ability to carry that debt. 

During the golden age of multifamily 2010-2015 this was actually a pretty rare practice as most cities were trading at equilibrium historical cap rates and the asset had the ability to carry the debt load. Come 2015 few deals could project the 7-10% COC a sponsor needed to make the deal work and competition among banks brought the IO to the 3-6 years we see today.

This presents its own set of problems especially in cities where multifamily is in the hypersupply side of the cycle. Everyone understands that once IO expires principle payments begin but what is not talked about is that effect on COC. I ran these numbers on my last deal and it came in the ballpark of eating 5% in the year of reset and thats with a stable interest rate environment. This means that if the asset doesn't have a minimum 5% COC it can't pay debt. As a sponsor or investor you better be pretty damn confident in how fast you can turn units, increase rents, decrease economic loss to lease etc; NO room for error. This is not what I see. I see less than 10% economic loss to lease, 30% year one rent bumps, renovations done in one year. Essentially your buying an asset running perfectly and betting you can run it even better. I

There are other products where IO on front end combined with longer term debt can meet both purposes. Unfortunately today the IO in conjunction with Bridge financing is the only way to make these deals work on paper.