Blanket Commercial Loan offered - Opinions?

Question

Hi all,

I'm looking for everyone's opinion on a commercial loan I have been approved for.

I own 6 multi-family income properties, all financed with 30fix at average rate of 4.9%. All cashflow positive, about $5,000 monthly EBITDA.

In order to access equity, I've been negotiating with private and commercial lenders. So far, the only offer that lets me tab equity is this:

Cross-collateralized, 5 year term, 25 amort blanket commercial loan. 20%LTV. Repricings variable at 1, 3, 5, rate depends on repricing. I'm leaning towards 1 year repr with a 2.99% rate. No change or lifetime caps on rate. Rate based on bank's cost of money which is not tied to LIBOR or COFI or 5YRTREAS, instead based on bank's actual CoM. No prepay pen, fixed rate option. Properties have to be put in LLC.

This loan comes with a 300K line of credit for additional properties which have to be approved by bank (read: cash-flow positive which they will be anyway). Not a cash-out, so no interest if I don't tab it.

As much as I hate letting go of the 30yr fixed, there is no other way for me to get the equity out. On the upside, it resets my 30yr fix count and I can buy with existing HELOC and cash as downpayments in addition to commercial LoC.

Opinions?

Thanks!

Account Closed · Answer

Sounds like a really great offer nonetheless. I think you cant go wrong! But, this is a major decision and I can see how some technical analysis or insight would provide some comfort in your decision.

Account Closed · Answer

When trying to predict long-term rate movements I was thinking more about your exit strategy in five years and what conditions would be like then versus your offered adjustable rate. I agree it would be difficult to do a sensitivty analysis comparing the CoM expected rates (and returns with your 300k) with your current 30 year fixed.

Account Closed · Answer

I don’t think anyone can predict what interest rate conditions will be like in five years. It's easy to predict short term rates are going to rise, and directionally we know where long term rates are headed, but the magnitude of those changes is unknown. I once did a back of the envelope calculation on long term rates using empirical research and data on the relationship between the fed funds rate and the 10 year treasury. The 10 year Treasury has always been anchored by the fed funds rates and spreads have consistently been 200-300 basis points over a 20 year period of time. The 10 year treasury tracks the 30 year fixed rate nicely. I think my calculations showed that even with really aggressive interest rates hikes by the Fed it would only result in a maximum 30 year fixed rate of about 6 percent in 3-5 years (using the 10 year Treasury as a proxy).

I would tend to think about this option you raise in terms of return on equity. How much equity do you have generating $5k/month? If you deploy this equity in another investment vehicle what type of returns do you hope to achieve? If you set these two scenarios up with ROE being your comparison metric you can then run a sensitivity analysis on rates to see how it affects your decision.

Thomas Richter · Answer

Mark,

thanks for the in-depth answer. I agree with your on Fed rate changes; however, my bank is essentially a private lender that does not borrow money from other banks or the gov. They don't resell loans either. In other words, their CoM is not tied to Fed prime, interbank, treasuries etc. and thus hard to predict. If the bank has a good day on wall street their CoM is lower. I figure the broadest economic and rate indicators are probably my best bet.

The ROE in the properties is... not sure how to answer this. The downpayments add up to about 150K, the rest is financed. Loans are about 560K. Value is about 1.2m. So I'm getting 5,500*12 net return on 150K investment per annum, not bad. The 300K equity to be pulled as credit line will go into the same kind of property. It will be a 100% financed purchase so that's more straightforward. Looking at a 80K purchase with about $850 net per month, so right around 12% without putting any cash in.

I guess my point is, even if I knew how to run a sensitivity analysis, I wouldn't be comparing apples to apples...

thx

Thomas

Thomas Richter · Answer

Mark,

duh, yes of course I meant 80%LTV... too many numbers for my old brain. I agree interest rates can only go up from here on, but I have 2% margin before I hit the current rate. Plus, the repricing lowers the principal every year if I go 1 year. If I aggressively or even moderately pay off I can soften the blow from a possible higher interest rate.

I guess the real decision here is whether I want to grow the portfolio slower, or take a higher risk with faster growth. That said, even if the rate goes to 8.5% I'm only breaking even and not yet losing money.

BTW, I can take the 1yr and then after the first year decide to lock in for the next 4yrs (or any increment), so it seems like I can manage that risk somewhat.

Thanks for the input.

Thomas

Mark Creason · Answer

Thomas,

Do you mean 80% LTV? I like the starting rate, but would be nervous about not having a rate cap.  Interest rates are going up at some point, as they are historically low.  I would probably want to do the 5 year, if I was going to consider this.  In my business, I usually see larger deals.  I have been advising people to take 10 year terms and go non-recourse when they are available.  Non recourse is probably not available on this type of property.  Good luck.

Mark