Tiller Hill Capital has closed a $600,000 commercial real estate loan on a single tenant commercial property in San Francisco’s South of Market area. The new financing enabled the owner to take out cash for other purposes and to lock in today’s low interest rates.
Rates have dropped on commercial real estate loans for multifamily (5+ units) loans. Here are three examples:
- 90% fixed for 10 years, up to 75% loan to value, 30 year amortization, due in 30 years, minimum loan amount of $1,000,000.
- 90% fixed for 10 years, up to 50% loan to value, 30 year amortization, due in 20 years, minimum loan amount of $2,500,000. For loans of $1,000,000 to $2,499,999, the rate is 4.025%.
- 95% fixed for 10 year, up to 55% loan to value, 30 year amortization, due in 20 years, minimum loan amount of $3,000,000. For loans of $1,000,000 to $2,499,999, the rate is 4.075%.
These are rates for A or B quality properties in larger metropolitan areas with strong credit borrowers and larger loan amounts. Not all properties will qualify. But they are indicative of more aggressive pricing we are seeing from multifamily lenders in recent weeks in effort to secure new business.
It is easy to focus on interest rate when choosing a commercial mortgage for a retail, office, industrial or multi-family property and miss other provisions that affect the borrower financially. Here are five issues to consider that can make a commercial property loan with a slightly higher interest rate the better deal.
- Restrictive Prepayment Penalty – In general, the more restrictive the prepayment penalty, the lower the interest rate. Commercial property loans generally have one of three kinds of prepayment penalties – Step Down, Yield Maintenance or Defeasance. Step down prepayment penalties are fixed penalties expressed as a percentage of the loan balance being repaid. The percentage drops every year or two. For example, for a five year fixed rate loan the prepayment penalty is often 5% in year 1, 4% in year 2, 3% in year 3, etc. Yield maintenance and defeasance penalty calculations are complicated but their objective is to compensate the lender more fully for the lost interest income that would have accrued had the loan not been prepaid. Step down prepayment penalties almost always result in a lower penalty than yield maintenance or defeasance, except in situations where interest rates are increasing – in which case the borrower is less likely to want to prepay the loan. More often, a yield maintenance or defeasance clause will make it cost prohibitive to refinance prior to loan maturity. Unless the borrower is certain they will not need to refinance or sell the property prior to loan maturity, they should consider paying a slightly higher rate and having the flexibility of a step down prepayment penalty.
- Short Amortization – Commercial mortgages most often have an amortization of 25 or 30 years, although, shorter and longer amortizations are not uncommon. The amortization has a big impact on the monthly payment and hence the cash flow from the property. A $1 million dollar loan with a 25 year amortization and a 4% interest rate will have a payment roughly $500 greater than the same loan with a 30 year amortization. If the borrower is looking to maximize free cash flow from a property, a higher interest rate on a 30 year amortization may be a better fit than a lower interest rate on a 25 year amortization.
- Required Impounds for Insurance and/or Taxes – Some commercial real estate loans require impounds for insurance and/or property taxes. The lender collects an amount each month sufficient to make the insurance and tax payments when they come due. The borrower is therefore paying the insurance premiums and taxes well in advance of when they would otherwise. In effect, they are making an interest free loan back to the lender.
- Loan Term With Narrow Refinance Window – Commercial real estate loans either come due at the end of the fixed rate period of they convert at that time to a variable rate loan. The latter are often referred to a hybrid loans. For example, a hybrid loan may have a fixed rate of interest for 7 years, after which the loan converts to a variable rate loan. Other loans have fixed terms equal to the term of the fixed rate. In the above example, the rate would be fixed for 7 years and due in 7 years. The rates on hybrid loans are a bit higher. But they offer more flexibility as to when the borrower refinances. A loan that becomes due at the end of the fixed rate period may force the borrower into refinancing at a time when interest rates are up or there are other issues with the property or the borrower’s finances that make refinancing difficult.
Commercial real estate loans on apartment properties can be tailored to satisfy a variety of borrower needs. However, borrowers are often frustrated by hearing “no” from the first lender or two with whom they speak. They may then assume their need cannot be met and may settle for a new or stay with an existing loan that does not fully meet their needs.
Getting to “yes” is possible – but it requires identifying the lenders best suited to the situation and then approaching them in the most effective manner. The latter is critical, as once a loan package has been reviewed by a lender’s internal staff and rejected, it is often very difficult to get them to reconsider, even when the basis for the rejection can be shown to be incorrect or easily mitigated.
Here are examples of situations where “yes” is possible with the right approach to the right lenders.
- Credit Challenges – Borrowers with less than perfect credit – late mortgage payments, loan modifications, foreclosures, short sales, BKs, low credit scores, tax liens, etc. – can often be accommodated. Lenders look positively toward borrowers that “hung in there” and worked their way through difficult situations. Rates may be a little higher than the lowest available apartment loan rates, but still attractive and significantly lower than those from private or hard money lenders.
- No Prepay Penalty – Some borrowers are unsure about their future plans for an apartment property and want to avoid incurring a large prepayment penalty should they sell or refinance. But they still want the peace of mind that comes with having a fixed rate apartment loan. Five and seven year fixed rate loans are available with no prepayment penalty. The rates are often competitive with similar loans with step down prepay penalties.
- Interest Only – Borrower’s may wish to have a lower payment at the first 1 to 3 years of the loan, particularly on a purchase money loan. The lower payment frees up cash for improvements or to allow time to adjust rents upward as units turn. Some lenders offer a period of interest only payments in the first few years of the loan, generally, for no increase in rate. The difference in payment is significant. For a $1 million loan at 4% on a 30 year amortization, the interest only payment would be roughly $1,400 less per month.
- No Personal Guarantees – Some borrower’s prefer “non-recourse” apartment loans, meaning that in the event of a default the lender’s recourse is limited to exercising its rights related to the mortgaged property or other collateral securing the loan. As such, the borrower cannot be forced to make up any potential shortfall out of other non-pledged assets. Such “non-recourse” provisions have exceptions, often referred to as “bad boy” carve-outs. These carve-outs include situations where the borrower commits fraud, misrepresentation or material omission when applying for the loan or in connection with on-going financial reporting required by the loan, attempts to transfer ownership of the property in manner not permitted under the loan, wastes or abandons the property, fails to remit rents or insurance proceeds to lender to satisfy the loan, or fails to maintain proper insurance on the property. Non-recourse loans were much more common in the past. They are less common today, but they are available.
- Longer Fixed Rate Terms – Many lenders offer commercial multifamily loans with rates fixed for 3, 5, 7 or 10 years. In smaller, tertiary markets, local lenders often offer only loans where the rate is fixed for 5 or 7 years, and then with an amortization period of 25 rather than 30 years. This can be frustrating to long-term holders seeking to lock up today’s low interest rates for as long as possible and/or those who prefer the lower payment of a 30 year amortization. However, there are 30 year amortizing options with rates fixed for 10 to 30 years available in almost all areas of California.
Tiller Hill Capital provides commercial real estate loans for apartment and commercial properties throughout California. We help owners navigate the complex world of commercial mortgages and secure low cost commercial real estate loans to acquire new or refinance
Tiller Hill Capital has closed a $1 million commercial real estate loan on a 29 unit apartment property located in Chico, CA. The owners were seeking a long term fixed rate loan. Tiller Hill Capital secured financing with a low 4% rate fixed for 15 years, which improved the owners cash flow and provides long term protection from interest rate increases.
Tiller Hill Capital has closed a $1.2M refinance of a mixed-use SRO/commercial property in San Francisco’s Chinatown neighborhood. SRO properties present unique financing challenges. We arranged a loan through a Los Angeles based lender who was able to offer better rates and lower transaction costs than those offered by local lenders.
All eyes are on Wednesday’s Federal Reserve meeting to see if they will begin this year to increase interest rates. Whatever they decide, it may have only a modest impact on borrowing costs for commercial real estate loans. The Federal Reserve may choose to increase the Federal Funds Rate, (the rate, according to Wikipedia, “at which depository institutions (banks and credit unions) actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.”). However, commercial real estate loan interest rates, either through bank, agency, CMBS or life insurance sources, are more closely tied to the yield on 10 year treasuries. And historically the yield on 10 year treasuries has been only loosely tied to the Federal Funds Rate.
Fannie Mae’s October 2015 Economic Forecast predicts that the Federal Funds Rate will rise from .1% today to .3%, .5%, .6% and .8% in Q1 through Q4 of 2016, respectively. But they expect the yield on 10 year treasuries to rise from 2.1% today to 2.2%, 2.2%, 2.3% and 2.4% in Q1 through Q4 of 2016. In short, their forecast is for the Federal Funds Rate to rise by 70 basis points and the yeild on 10 year treasuries to to rise by only 30 basis points. More info is available at http://www.fanniemae.com/resources/file/research/emma/pdf/Economic_Forecast_101615.pdf. If that holds true, even if the Fed begins to raise the Federal Funds Rate, rates on commercial real estate loans can be expected to rise only modestly in 2016.
That said, rates remain near historical lows and no one is expecting rates to go down. And a 10 to 30 basis point increase in borrowing cost for a multi-million dollar commercial real estate loan can have a significant impact on cash flows. So locking up long term borrowing costs on apartment and commercial properties now just makes good sense.
Tiller Hill Capital this week closed a $1.8M refinance of 40-unit apartment property in Beaumont, CA. The non-recourse loan featured a 10 year fixed rate in the low 4% range and included cash out. The owner was able to lock in today’s low rates and free up equity to make an additional commercial real estate investment.
Tiller Hill Capital has closed a $500K refinance of multifamily property in Santa Barbara. The owner was able to replace a seller note with permanent financing and to take cash out to make improvements to the property.
Tiller Hill Capital closed a $1.2M refinance of a 14 unit apartment property located in Hayward, CA. The new financing provided a 10-year fixed rate of less than 4% on a 30 year amortization, allowing the owner to improve cash flows and lock in today’s low rates.