In the evolution of mortgage financing, lenders have expanded the boundaries to include a rainbow of options. The recent recession has decreased the colors in this rainbow, but we still have five hundred more options today than our grandparents. Ok, may that's a bit of a stretch, but only a little
If we were building our very own mortgage loan what would that look like? In the real world, no zero interest, self-liquidating options. Here are the four things I would want in every mortgage. The "wish list" items are all beneficial to the borrower.
Reasonable leverage. A lenders willingness to provide a 75-80% loan-to-value mortgage is separate and distinct from the borrower’s decision to leverage to that level. What is the appropriate leverage given the goals and objectives of the property owner?
Wish list item: 1.50 (DSC) debt service coverage. (where annual Net Operating Income equals 150% of mortgage annual mortgage payments)
Leverage is often a function of risk appetite. Yes, yields can increase substantially with increased leverage, but so does potential loss of equity. There are a multitude of variables that impact getting to a 1.50 DSC; purchase price, cash in, etc. Big variables. Just note that obtaining "peaceful sleep" is much easier with greater DSC.
Fixed Rate Financing. Variable rate mortgages are used predominantly to allow deals to work in varying interest rate environments. Rates that float invariably increase. It's a timing game.
Wish list item: A fixed rate that is actually "fixed" for the entire amortized term of the mortgage.
Long-term Amortization. A 30-year commercial mortgage is hard to come by these days. Granted, the amortization rate may be 30 years, but the term of the loan is invariably shorter. This is one reason why loans from GSE's (Government Sponsored Entities) have become so popular as they continue to offer an actual 30 year term.
Wish list item: No pre-payment penalties allowed under any circumstances.
The longer the term of the mortgage, the greater the flexibility. We can shorten the amortization by increasing monthly payments towards principal (although this is seldom done). However, many CMBS loans forbid principal reductions.
Wish list: A long-term mortgage with no restrictions to principal reduction payments (mortgage pay down)
Accurate Assessment of Cap Ex. Projecting capital expenditures pre-acquisition is of great use and comfort to long-term owners. While we cannot plan for every contingency, it is imperative (and progressive) to plan for known capital expenditures.
Wish list item: A capital assessment that is absolutely real, accomplished by an un-biased professional, one who owns no rose colored glasses. An assessment by an honest actor
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Multifamily Insight is dedicated to assisting current and future multifamily property owners, operators and investors in executing specific tasks that allow multifamily assets to operate at their highest level of efficiency. We discuss real world issues in multifamily property management and acquisitions. This blog is intended to be informational only and does not provide legal, financial or accounting advice. Seek professional counsel. For more information, visit: www.MultifamilyInsight.com
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