As you are starting to look at different investments, you may notice that there are many different ways to get financing. Depending on the investment size, scope and strategy, many syndicators deploy different methods of financing to acquire these assets. By the end of this, you should be able to identify and broadly understand the different terms and concepts of debt financing.
Long-Term – Fixed Rate vs. Short-Term
There are two different types of financing and they can be used together depending on the situation to give the investor the best return and the ability for the syndicator to achieve that goal. The most popular that you will see are the long-term options. These are loans by Fannie Mae, Freddie Mac, HUD and CMBS. Some of the short- term options in financing are the bridge loans, conventional bank and credit union loans, and variable rate loans.
Recourse vs. Non-Recourse Loans
First of all there are two general categories of loans, recourse and non-recourse loans. Your traditional banks and credit unions usually offer recourse loans. These types of loans are secured by the collateral and give the lender the power to go after any asset by the borrower to recoup the loan amount. An example of recourse loans are car loans. Since a car is a depreciating asset, the value of the car may not be the same value of the balance of the loan. So being a recourse loan, the lender can go after you and your assets to recoup the difference.
Non-recourse loans are the best loans when it comes to commercial real estate investing. These types of loans favor the borrower versus the lender. For example, an owner of an apartment complex could not pay what is owed to the lender. The lender can only take the keys of the apartment complex and the borrower can walk away. This is not good business practice or ethical or moral but it does give some protections.
Assumable and Supplemental Loans
These two strategies are used to purchase commercial real estate assets depending on the financial environment. These are tools that a syndicator can use to acquire an asset, more funds to complete the value add strategy, give partial return to investors and can be attractive to certain buyers.
An assumable loan is exactly what it says. It is a loan that can be transferred to the next owner. This can be attractive to a buyer if the current market has higher interest rates compared to the loan being assumed. All of the long-term financing servicers of loans offer assumable loans.
Supplemental loans are secondary loans that are offered by the same lender of the original loan. The benefits of a supplemental loan in apartment syndication is that the cost of securing this type of loan is lower than a refinance, faster processing times, the ability to return a portion of the investors initial equity investment, and have more funds to complete the value add strategy.
Loan Key Terms
As you start diving deeper into looking what commercial real estate investment works best for your goals, you will see different variations of loans. The first term is the length of the loan can vary from each investment. Usually for Fannie, Freddie and CMBS (or Agency loans), the lengths range from 7-12 years. Bridge loans length are usually 3+1+1.
The second term to recognize is the interest rates for these loans. For most Agency loans, the interest rates are fixed but they do offer floating rate options. Another key term is the interest only period. This is the number of years where the borrower only has to pay the interest. This can be beneficial when doing a value add strategy on a multifamily asset. It will help the syndicator keep costs down as they are repositioning the asset.
The final term you need to know is pre-payment penalty. This fee or penalty protects the lender if the owner is trying to pay off the loan early. The lender has calculated the profits from the loan over a period of time. The prepayment penalty helps the lender compensate for that if the loan is paid off early.
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