How Are Long-Term & Short-Term Rates Determined?

How Are Long-Term & Short-Term Rates Determined?

There are obvious differences in pricing for money that is lent for 5 years versus that which is lent for 15 or 20 years. What factors go into pricing the costs of these funds? In this article, we’ll give an overview of short-term versus long-term money, how’s it’s priced, and what influences the costs.

Multifamily Properties: What Are Lenders Looking For?

By Venture Mortgage Corporation

See the first article in this series entitled, "The Foundations of Commercial Real Estate Financing".

Now that we’ve gone over the basics of commercial real estate financing, it’s time to discuss how a lender comes to agree to mortgage your commercial property.

In this article, we’ll discuss the lender’s point of view on a multifamily loan and find out what they are looking for when considering the investment.

Lenders need details, so you should be prepared with as many records as possible to allow for a full understanding of the lending situation.  For this property type, lenders look at several components when deciding whether a property is a good investment and if the loan is likely to be repaid as agreed:

1)      Current and Historical Cash Flow: Lenders want to know that the property will generate sufficient cash to make the monthly debt service (mortgage) payments. In the case of the multifamily property, lenders will analyze the current rent roll (a consolidated report showing the names of tenants, rent amounts, and lease termination dates) and expenses to determine net operating income. Net operating income, or NOI, is defined as income minus expenses before mortgage payments. Lenders use a ratio known as the debt service coverage ratio (DSCR) to ensure that cash flow is sufficient to cover the mortgage payments with some additional cushion, and they generally like it to be >1.20. DSCR is the NOI divided by the annual mortgage payment, and a positive DSCR reflects a property with a positive cash flow.

2)      Borrower’s Financial Situation: A lender will need to feel confident that the borrower, borrowers, or borrowing entity is in good financial standing. This generally means having liquid capital (read:cash in the bank) available for at least 20% down toward the purchase price of the property and the equivalent of 6-9 months’ mortgage payments worth of capital reserves. Additionally, lenders will often look at a borrower’s personal credit score: anything under 680 will raise questions about repayment willingness and ability. Any past adverse credit action (foreclosures, short sales, liens, judgements, and collection accounts) will need to be documented, explained, and corrected to the lender’s satisfaction.

3)      Condition of the Property: The lender will want to look at the property and the surrounding area. Is the area rapidly decreasing in population or in an economic decline? Does the population support an acceptable (low) vacancy rate? Are the current rents reasonable and sustainable? Are the amenities of the property available in line with other comparable properties, ensuring that it attracts occupants in the market? Is there deferred any deferred maintenance (i.e., a roof that will need to be replaced in the next six months)? An appraisal will evaluate the market value of the property considering these and other pertinent factors. Remember, lenders base loan amounts on the appraised value of the property and its ability to cover the debt service (i.e., a DSCR >1.20), not the price that the seller is asking. If the appraisal comes in far below what is expected, the lender will hold to the loan-to-value metric based on the appraised value.

This is a fairly extensive, but not exhaustive, list of lender considerations regarding multifamily properties. A lender would not be doing you, or itself, any favors by accepting mortgages on properties that are unlikely to cash flow and increase in value. Additionally, a poor multifamily investment can spell financial ruin for a new (or any) investor, especially one without sufficient capital reserves to weather an unexpected storm.

1031 Exchange: Tips & Pointers

Venture Mortgage is proud to feature this guest post by Jeff Peterson, President of CPEC1031 - Commercial Partners Exchange Company, LLC. Jeff is a licensed attorney in Minnesota, and is a renowned expert in 1031 exchanges and tax considerations in commercial real estate. Here, Jeff speaks to the nuances and benefits of 1031 exchanges for commercial real estate investors.

The Foundations of Commercial Real Estate Financing

By Venture Mortgage Corporation

Are you considering the purchase of your first commercial real estate property? It’s an attractive proposition: the first rule of building wealth is to increase assets and limit liabilities, and income-generating real estate, properly managed, will add to one’s net worth and increase one’s economic security. However, it is important to be a well-informed investor, and there are some key considerations that are especially vital for first-time commercial property buyers to understand. In the first segment of this series, we will begin to understand the wide world of commercial real estate financing.

1)      Understand property types: What type of property are you pondering? For many first time buyers, multifamily rentals are the default choice, as they are familiar with residential property as renters and/or homeowners. It could be that office, industrial, or retail properties are a better fit for your goals and career experience, but do keep in mind that the cost of acquisition for these property types are often significantly higher than the multifamily sector. Commercial properties are generally divided into five general categories: retail, office, multi-family, industrial, and special use (land and land development are a separate phenomenon that beyond of the scope of this writing). Within these categories, properties are further divided based on location and condition. The type and classification of the property you decide to buy is a very important consideration when it comes to obtaining financing and in calculating potential return on investment. Speaking of financing…
2)      Commercial real estate financing is potentially quite complex : Most commercial real estate buyers are familiar with the process of obtaining a residential mortgage, but financing a commercial real estate property is generally very involved and can be intimidating to first time investors. The loan origination process is unique to each property and buyer, and there are many lending sources, each with its own advantages and disadvantages. Investors should expect to come to the table with at least 20% down for the majority of properties, as lenders are generally not willing to go over an 80% loan-to-value (the ratio of the outstanding debt to the value of the property). This means that, for a $1,000,000 property, one should be prepared with a minimum of $200,000 toward the purchase. Appraisals are usually required, as well as a number of other third-party inspections and reports as a part of due diligence: these typically include environmental reports, title searches, an American Land Title Association (ALTA) survey, and more as requested by the lender. These third party reports, combined with loan fees and legal costs, can add up to thousands of dollars very quickly. Lenders consider a wide array of factors when they underwrite loans: for example, a particularly risk-averse lender may be uncomfortable lending on an 80 unit apartment building to a first-time borrower with no property management experience, even if said borrower comes with a considerable down payment. This is why it is vital to…
3)      Know your lending options: Did you know that you can borrow money from a life insurance company to purchase an office building? How can you tell which bank is best for a property in a secondary market? Do credit unions even do commercial real estate loans? How do you know if the rate you’re being quoted is a good one? Which lender is the best choice for me and my situation? There are ways to answer these questions and make informed decisions. A commercial real estate mortgage banking firm is a company that has established relationships with a wide variety of capital sources for the purpose of securing commercial real estate financing for borrowers. By shopping an investment to life insurance companies, banks, credit unions, agencies, and commercial mortgage backed securities (CMBS) lenders, the firm is able to inform the investor about the options available, simplify the origination process, and secure the most favorable rates and terms for the client. In some cases, such as with life insurance company lenders, loans are only available through commercial real estate banking firms (which will act as a conduit); by not consulting with a mortgage banker, borrowers are potentially excluding lenders who will offer the best available loan package. A consultation with an experienced mortgage banker at Venture Mortgage regarding a potential purchase is always complimentary. In fact, Venture Mortgage is only paid a fee if we secure financing and close a loan for you on your terms, and our many satisfied clients speak not only to the savings they realize with us, but also to the superior service they receive during the origination process and throughout the life of their loans.

In the upcoming segments, we will take a closer look at the loan approval process and answer the question, “What Are Lenders Looking For?”

We will also begin to the understand the fundamentals of the different property classes in “Property Types: How Commercial Real Estate is Defined and What It Means For Financing”.

Does Your CRE Investment Pass the Stress Test?

By Venture Mortgage Corporation

Lenders use DSCR as a first-look; commercial real estate investors would be wise to do the same.

(Read part one here.)

The Federal Reserve has opted not to raise rates in September 2015, but experts speculate that the rate hike has only been delayed for a short time. When rates do eventually rise, it will allow institutional investors and funds to deploy their assets in other locations – namely bonds – and will hopefully stop the chase after yield by purchasing real estate at 4%, 3%, or even 2% cap rates. This will be a good thing for the stability of the commercial real estate world: while it does correlate with rising interest rates for investors and the debt placed on properties, this should level out the “crazy” deals being done, or at a minimum, keep deals in check.      

It is vitally important to “stress test” any purchase or refinance you are currently pursuing by:

1)      Finding the 1:1 DSCR in terms of value and rents received.

2)      Considering changing cap rates: if a property is purchased at a 6% cap rate, evaluate what it looks like at a 9% or 10% (closer to historical averages) cap rate.

3)      Evaluating changes in market rents: if rents fall 5%, 10%, or 20%, what will happen to the ability to cover the debt service?

If very small moves in the market cause the property to be classified as underwater, it is probably a good sign to turn and run, or, at a minimum, start getting financial reserves in order to cover a potential shortfall.

To avoid this type of rate risk, lock in rates for the long haul. There are a variety of lenders offering 10 year, 15 year, 20 year, and even 25 year fixed rates on commercial real estate properties. A trusted and experienced Venture Mortgage Banker will be able to quickly assess your portfolio and help you to explore lending options to lock in rates for a long fixed-period. This will allow you to take risk off the table for the near and not-so-near future, as well as capitalizing on the historically low rates and high valuations we are seeing in the market today.

There are numerous other metrics, ratios, and tests used to determine the strength of a real estate investment. However, if you are an investor who uses debt as a tool to gain wealth, it is important to understand this basic stress test associated with the Debt Service Coverage Ratio, as well as being aware of the challenges associated with rising interest rates and plateauing values.

Debt Service Coverage Ratios Explained

By Venture Mortgage Corporation

What Is A Debt Service/Coverage Ratio, and What Does It Mean For My Commercial Real Estate Portfolio?

Debt Service Coverage Ratio (DSCR) refers to the ratio of Net Operating Income (money left over after the bills are paid) over the amount of debt service (mortgage payment) contributed to a given property. Typically, a lender wants to see a DSCR equal to or greater than 1.25.

Lenders want to see the cushion afforded by the positive DSCR so that if there is a hiccup in the operation of the commercial property, there is room to absorb the blow and still be able to cover the obligation of paying the mortgage. Given our example above, let’s assume the $40,000 debt service represents a loan of $625,000 with a 4% interest rate with a 25 year amortization – and that expenses are normalized and under control. As you can see, with just a small rise in interest rate, the loan looks significantly less appealing to lenders, and can put the borrower in a precarious financial position:

Matt- DSCR Stress Test Sept 2015 Graph 2.png

Given the current historically low interest rates, investors are able to fix mortgage payments (debt service) at an extremely low dollar amount, making the DSCR on many of these properties look extremely good (read safe) in the eyes of the lenders.

However, once we consider that property valuations are nearing all time low capitalization rates (cap rate) and that the rental market has seen a now double digit increase in rents, it seems we could be nearing a crisis that will see commercial real estate owners running for the hills on their next round of financing.

 

100% Leased - But At What Cost?

By Venture Mortgage Corporation

We all realize-  at least on a basic level- that a commercial building is only as good as the rents it can produce. One of the main components of obtaining financing for commercial space involves the analysis of the current rent roll (a rent roll is a list of tenants with the rent amounts and expiration date for each tenant).  Questions about the current vacancy, historic vacancy, current rent per square foot, average lease length, and lease rolling periods are a few of the basic concerns lenders have that will need to be addressed during the underwriting of a loan.

So, is it in your best interest to get open spaces leased, even if you have to discount the new tenant to fill it?

In many cases, probably not. Here's why: if a property currently has a vacancy of 20%, and the owner would like to get that rate down to 10%, it may seem prudent to lease at a discount to lower the vacancy rate. However, if you are currently leasing at $10/Square Foot, lowering your rate to, say, $6/SF in order to attract new tenants could cause your entire property to be viewed by lenders as having a market value of $6/SF, since many lenders will take the newest price per square foot as the "market" rent for the area and use that figure when underwriting the loan.

If you find yourself in a situation where you are considering lowering rents to fill space and are looking to refinance in the next 18 months or so, it is important to contact a seasoned mortgage banker as your partner to assist you with a personalized situation analysis. Venture Mortgage has over 25 years of experience in commercial real estate, and we are experts in helping you to leverage your property and increase wealth without causing harm to your property value. Additionally, we have close relationships with a wide network of lenders willing to lend in a variety of situations.
 
Here's the takeaway: make sure you keep in mind the overall impact of how you lease up that last bit of space, especially if you are looking to place financing in the near future.

Life Insurance Companies as Lenders

By Venture Mortgage Corporation

Understanding the Power of Life Company Funding

When most of us think about life insurance companies (also known as “life companies”), we think of purchasing a policy to plan for the future. However, thinking about what life companies do with our premiums will help you to understand why life insurance companies are an excellent source of capital financing for commercial real estate.

Life companies think in the long term: premiums are collected over a period of decades, and making stable, long-term investments is how life insurance companies ensure that funds are available when a benefit payout comes due. While life insurance companies do invest in some stocks and bonds, about 1/3 of their multi-billion dollar portfolio of investments is CRE, or commercial real estate. Because of this long-term outlook, life companies are often willing to make 10, 15, 20, or even 25 year long term fixed loans; in contrast, most big banks prefer short term loans because they generally like to focus on more immediate returns. Of course, the stability of knowing what to expect for many years to come presents a distinct strategic advantage for you as a commercial real estate investor!

The next question that comes to mind is: “How can I get access to the capital and favorable terms that life companies have to offer?

The answer is that Venture Mortgage Corporation has been entrusted by life companies to bring commercial real estate investments to the table. Venture Mortgage has formed key strategic partnerships with several major life insurance companies looking to finance commercial real estate transactions. If you are seeking favorable rates, superior service, and a partner to make sure you are getting the most favorable terms possible, contact Venture Mortgage today to discuss your financing goals.

For more than 20 years, Venture Mortgage has been interacting with borrowers and lenders every single day to deliver creative, cost-effective solutions for commercial real estate transactions. As a result, we have forged long-term, trusted relationships with lenders and clients alike. We deliver our clients the most competitive commercial real estate financing structures available in the marketplace. Why not call us now to get a comparison rate quote? Contact us today: we can give you the ability to make a fully-informed decision about available mortgage rates and lending sources available to you!