Commercial loan balloon payments
Real Estate Professional · Las Vegas, NV · Member since 2013 · 225 posts · 74 votes
Commercial loan balloon payments
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Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
12yLenders will sweet talk you when you ask about this risk. They'll tell you that they "typically extend" the loan and when you probe they'll start to play all sorts of games. The simple fact is that they'll do what is in THEIR best interest if the environment isn't right to extend the loan because their ratios are out of whack. If you have a 10-year loan you should have a multi-year window to work on a refinance and should not wait until the very end of the loan to extend your term.
For many investments your optimal sell year will come before year 10 after you have improved operations. Holding for additional years will decrease the return on your equity. You need to size your debt duration to the business plan for the property you're working on. If you intend to hold the property forever and the rates are as low as they are now you should pony up the small premium and get 30-year money if it exists for your project type. It will be money well-spent.
Make sure to ask about prepayment penalties, lockouts, etc. when you are pricing the money. The market for commercial loans is quite different than residential loans, which are largely a commodity with all of the gov-mint interference in the market.
17 Replies
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes12y
Second hand experience, perhaps. I have an investment in a partnership that owns a mini storage. We had to do a refi last year to pay off the balloon. The original lender extended the loan for a few months (at a significant charge) but would not roll it over. It was a struggle to find a new lender and we ended up having to do a cash-in refi.
No, you cannot count on the lender just rolling it over. You will need to refi or sell if they won't. @Joel Owens works in this space and may have some advice.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
Hi Alex,
Most local banks have balloons in five years actually. Some regional banks have 7 to 10 year balloons if you search for it.
The 5 year loans have the lowest interest rates typically but the most risk. There is more time with a 7 to 10 year loan term to pay down the payoff balance.
What you have to calculate is RISK EXPOSURE with the loan you are seeking to obtain. You plan your exits ahead of time for the worse case scenario. There is some longer term money out there but the loan is actually from what I have seen 50 to 100 basis points higher on the rate. So you get longer security on the loan term but less cash flow from the start between the buying cap and the debt service going in. With the longer term loans there can also be hefty pre-pay penalties built in. Remember when interest rates rise the lenders are still getting the same rate from you but less return which is why they like short term loans.
I am not a fan of the five year loans because of refi risk and balance exposure if you want to leverage. It all depends on the buyers liquidity after purchase and down payment and what kind of risk they can stomach and still be okay.
- 12yJ. MartinPro MemberRental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
I work in bank regulation and have seen hundreds of both tight refi and workout deals on CRE, and specifically MF, although I do not invest in commercial myself because I like 30yr money too much at this rate and haven't hit my conventional cap yet..
You SHOULD NOT rely on your lender to roll it over. They will generally do whatever they think is in their best interest. And that can vary widely from lender to lender. For some, it may not be worth their time, and they'd rather just take their lumps and sell it for you if you don't (aka, foreclose if you can't refi or sell). You can also see from publicly available information from banks that there were also many Troubled Debt Restructures (TDR) that took place, where lenders temporarily reduced rates or made other concessions at renewal due to the borrower's financial weaknesses, with the expectation that they would recover more overall in this scenario. But you can't count on this.
Generally, if you have the resources to right-size the LTV and DSCR, they're not going to refi and let you off the hook without it.. (I'm guessing that's what happened with @Jon Holdman . Him and his partner likely had the resources to do inject equity in one way or another, so the Bank forced them to do it). If you have absolutely no reserves, underwater LTV, bad economy, nothing to cross-collateralize, etc, then you're probably more likely to get to the bargaining table . But at that point, you've risked losing everything. Lesson here is reserves, reserves, reserves, and don't get too overleveraged..!
- Investor · Omaha, NE · Member since 2011 · 475 posts · 211 votes12y
That's always the balancing act that must be done with financing and you must make sure you don't over pay on the buy. Leverage is a double edged sword and to be prudent I never use less that 75% LTV. I have a mix of 5 and 10 yr loans as all are commercial properties. Is there some rate risk? Yes, but ,each time they renew the balance is less and the properties will have apprecitated as they are located in a stable market with good employment. Makes a world of difference.
- Investor · Omaha, NE · Member since 2011 · 475 posts · 211 votes12y
Correction: I meant to say never use MORE THAN 75% LTV, sorry
One of my last land deals was with a seller who couldn't get the bank to roll his loan over. Its tough times, and they were putting a lot of pressure on him and his wife. I ended up paying only 10% over his existing note balance. Plan accordingly.
- 12yJ. MartinPro MemberRental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
@Joel Owens , they don't do 5/1, due in 10 out there? I know it can differ quite a bit from location to location. In CA, if you call around, common loans for multifamily are 25% down, 30yr am (on MF, 20-25yr am on other CRE), 1.25 DSCR, a 5/1 ARM is often due in 10 years, with resets from 5-10 years and 3/2/1% prepayment penalties for first 3 years. This can vary a bit though too..You have to be prepared for the reset on your cash flow either way, but at least you don't have to panic about getting cash-in and refi quickly in 5 years with due in 10. And pricing is almost exactly the same, because they get the variable rate vs 10-yr fixed.
Separately, one thing some CRE investors forget to check is what their index is - prime or LIBOR. Consensus is generally that LIBOR will move more quickly upward, while FOMC may lag on on discount rate/prime.. Know when your rates reset and potentially how far.. The 30yr bull market for bonds and ever-decreasing rates is over :( Doesn't mean we'll be at 6% LIBOR next year. But there is a full economic and interest rate cycle ahead of us in the next decade. Hopefully rents will keep pace or beat ;)
I haven't had trouble refinancing balloons yet, but I definitely perceive it as a risk. I have a 5/15 coming due in 3 years, and am currently about 65% LTV. A good thing about the relatively short 15 year am, is that by the time the balloon is due, I should have 50% LTV, even with no appreciation.
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes12y
In our case the lender would only roll over the loan for a few months while we completed the refi. Had we not, they would have foreclosed. It was very clear they would not do a long term roll over. I was not directly involved, being only a limited partner. But the general partner went through about a half dozen lenders and something like $75,000 in various fees to get a $1.2-ish million dollar loan. And we had to inject another $250K or so of cash from the investors to make that happen. I didn't put money into this second round of investments. All of those of us who had money in on the first round (which includes all the folks who were in on the second round) have seen the value of our investments drop by about 70%. But that beats the 100% loss we were looking at for a while.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
J Martin yes I have seen the loans you are describing.
They are more conduit lenders than local banks.
Many areas of CA is a spec market so lenders view the product differently than in other states. For instance Chase has branches in GA but they do not do any commercial lending here really ( not counting SBA stuff ). The national bank prefers to loan on ultra vanilla stuff in Cali and in New York and Washington etc.
Each bank kind of has their own way they view CRE and their strategy they want to employ based on goals. Each loan has a plus and a minus to it. Some local or regional banks will do a loan in a certain area where a national bank will not touch it. So it's all about the options available for that property and that location is what I am seeing.
- Real Estate Professional · Las Vegas, NV · Member since 2013 · 225 posts · 74 votes12y
Jon Holdman,
Thank you for the additional details. Why do you think the bank was so unwilling to budge? Did the property drop in value or profitability by a significant amount recently?
- Investor · Fernandina Beach, FL · Member since 2012 · 95 posts · 14 votes12y
Thanks @Jon Holdman for that real world example and expertise. I always wondered how these refi's went down in unfavorable situations so I really appreciate the details from that scenario as an anecdotal example.
I do wonder about the decision making process from the banks perspective on a deal like that... it seems like if the property is that far underwater they would be more willing to negotiate terms, no? I guess @J. Martin might have hit the nail on the head and they figured the partnership was solid enough for another raise to put the deal together???
Seems like a game of chicken to me.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes12y
Lenders will sweet talk you when you ask about this risk. They'll tell you that they "typically extend" the loan and when you probe they'll start to play all sorts of games. The simple fact is that they'll do what is in THEIR best interest if the environment isn't right to extend the loan because their ratios are out of whack. If you have a 10-year loan you should have a multi-year window to work on a refinance and should not wait until the very end of the loan to extend your term.
For many investments your optimal sell year will come before year 10 after you have improved operations. Holding for additional years will decrease the return on your equity. You need to size your debt duration to the business plan for the property you're working on. If you intend to hold the property forever and the rates are as low as they are now you should pony up the small premium and get 30-year money if it exists for your project type. It will be money well-spent.
Make sure to ask about prepayment penalties, lockouts, etc. when you are pricing the money. The market for commercial loans is quite different than residential loans, which are largely a commodity with all of the gov-mint interference in the market.
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes12y
We bought that property in early 2007, at the end of the bubble. When we did the refi, new lenders looked at income for the previous five years. 2007 and 2008 were tough years. The bubble popped, and housing activity is a significant driver of mini-storage revenue. This property is in Mobile AL and was affected by the Air Force decision to award the new tanker contract to Boeing instead of Airbus, which significantly impacted the job market in Mobile. The property is improving, but compared to 2007, the value was down when we refinanced in 2012. This is no different than a loan on a house. Leverage is great when prices rise. It cuts with prices fall.
- Lender · Westfield, NJ · Member since 2010 · 85 posts · 23 votes12y
I am a CRE lender. From a lenders perspective the bank would prefer a shorter term(longer term more perceived risk). As a borrower I would want to lock up my fixed rate for as long a term as possible. 10-year terms with commercial bank is possible but preference i s 5-7 years. Amortization schedules vary but for mult-family a 30 year amortization schedule is common. A lot depends on the type of property being financed. As a borrower when you are looking at a deal you should look at things under a stressed scenario.-higher rate at time of refinance maybe higher vacancy/credit. Again if its commercial property i.e office or retail bank will look at lease expiration schedules. Banks don't like rollover risk as it creates uncertainty to cash flow. This is less of an issue with multi and a higher v&C allowance in your stress test and higher projected rate assumption will address this risk.. Need to factor reserves. If LTV is in line typically not exceeding 75% and banks debt service coverage threshhold is being met usually no less than 1.25X a refi by existing lender is possible.; You should always be prepared for the possibility that a lender will opt not to refi at maturity and start having a conversation with your lender comforatbly in advance of maturity date.
Hope this was helpful.
- Flipper · ankeny, IA · Member since 2017 · 5 posts · 0 votes9y
I just went thru a divorce last year and acquired our 90 units. 45 of them had a baloon loan. The lender , although having well over 50 % in equity, would not just do a loan for me. They extended it 120 days so I could sell it.
Now that I have several offers and scoped out the competition, I see there is nothing on the market like my property. I actually owe just 25% of what I am being offerred. I almost think I should go for it, however, they are not friendly to multi family...
I would have refinanced before the divorce had I known it was a balloon . They stink.
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